First guest post - Ben Hamlin on s47 penalties

I'm really pleased to announce the blog's first guest post - from Ben Hamlin, Barrister (Ben@hamlin.law). Our shiny new Commerce Amendment Act 2022 has got most attention for its (welcome) rewrite of s36 along Australian lines, but as Ben explains, there are other provisions which you need to be on top of. Ben's written about the increased penalties which will apply from May 5 to parties who breach s47 (anti-competitive mergers or acquisitions). As it happens, the Commerce Commission has been more active in recent years in opening s47 inquiries: Ben reviews the history and draws the lessons. Enjoy!

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Increasing penalties for anti-competitive mergers

Merger activity is booming, so practitioners in that field might be forgiven if they had overlooked the forthcoming increase in penalties for mergers that contravene section 47 of the Commerce Act.

The increase is worth noting, but also provides an opportunity to reflect on merger enforcement in recent years.

The potential penalties for mergers are on the up

The first substantive provisions of the Commerce Amendment Act 2022 come into force on 5 May 2022, including an increase in the corporate financial penalties associated with mergers that substantially lessen competition. From 5 May onward, the maximum penalty will be the greater of:

(i)                  $10 million:

(ii)                 either,—

(A) if it can be readily ascertained and if the court is satisfied that the contravention occurred in the course of producing a commercial gain, 3 times the value of any commercial gain resulting from the contravention; or

(B) if the commercial gain cannot readily be ascertained, 10% of the turnover of the person and all its interconnected bodies corporate (if any) in each accounting period in which the contravention occurred.

As is often the way, the change in merger penalties barely rated a mention in the passage of the Commerce Amendment Act 2022. At the third reading Hon Andrew Little, speaking in the place of Hon David Clark, noted:[i]

Another important way that the Act protects the competitive process is through its prohibition against anti-competitive mergers or acquisitions. For this prohibition to be effective, it needs to be able to deter entities that may benefit significantly, in commercial terms, from the merger. The bill ensures this can happen by increasing the monetary penalty the courts can impose if entities are found to have contravened the prohibition.

This change brings the penalty into line with contraventions of Part 2 of the Act, and broadly into line with the penalties for a breach of the equivalent provision in Australia.[ii] The increase from $5,000,000 to $10,000,000 is also broadly in line with inflation since the penalty was set in 1990.[iii]   

So far, very orthodox: deterrence through ensuring that the potential benefits are outweighed by the potential penalties.

Does an increase in non-notified merger investigations suggests inadequate deterrence?

An interesting further justification was provided in the Cabinet paper approving the decision to increase the penalty. The Courts have cautioned against placing much weight on cabinet papers when interpreting legislation.[iv] Any judges reading may wish to avert their eyes.

The paper noted that: [v]

“Since the beginning of 2018, the Commerce Commission has undertaken investigations into eight possibly anti-competitive mergers for which clearance or authorisation was not sought. This suggests that the current penalties for anticompetitive mergers are not acting as a sufficient deterrent.”

Does it? As the readers of this blog will be aware, the penalty is only part of the optimal deterrence equation. The probability of detection and prosecution is equally, if not more, important.

The Commission’s merger enforcement 2010/11 to present

The Commission’s published merger statistics show that there was indeed a real spike in s47 investigations.[vi] In the seven years between 2010/11 and 2016/17 there were a total of 11 section 47 investigations decided. Yet in the two years 2017/2018 and 2018/2019 a further 11 section 47 investigations were decided.

Financial year	10/11	11/12	12/13		13/14			14/15			15/16			16/17		17/18		18/19	19/20		20/21		21/22 HY	Total
Clearances (s 66)
Total applications decided	10	10	8		12			14			12			7		9		11	9		8		10	120
Unconditional clearance	8	8	6		9			11			9			3		5		8	9		6		6	88
Clearance with divestment	2	1	0		2			1			2			0		1		2	0		2		1	14
Declined	0	1	1		0			2			1			3		2		0	0		0		0	10
Withdrawn	0	0	1		1			0			0			1		1		1	0		0		3	8
Section 47 investigations
Number decided	1	3	2		1			2			1			1		7		4	1		2		0	25

Table 1 Source: Commerce Commission Merger Determination and Enforcement Statistics - December 2021

What could have caused the jump? It is difficult to distinguish correlation and causation. But many competition law tragics will remember a heady period where the Commission blocked five transactions in 13 months: Sky/Vodafone February in 2017, Aon/FPIS in March 2017, the NZME/Fairfax Authorisation was declined in May 2017, Vero/Tower in July 2017, and Trade Me/Limelight in March 2018. Appeals were filed against three of the decisions (Sky/Vodafone, NZME/Fairfax, Vero/Tower), but two were withdrawn and the NZME/Fairfax appeal proceeded unsuccessfully.

It is possible that blocking a number of high profile mergers in quick succession caused some parties to avoid clearance. In any event, the increase in section 47 investigations did not escape the Commission’s attention. In August 2018, the Commission announced its priorities for 2018/2019, and ‘non-notified mergers’ was among them. The Commission’s then Chair was quoted as saying:[vii]

“New Zealand is one of a few jurisdictions with a voluntary merger clearance regime and the Commission is seeing an increase in non-notified mergers. Over the past 2 years we have opened five investigations into non-notified mergers. The success of a voluntary regime relies on the credible threat of enforcement proceedings so we will act quickly in these cases to prevent adverse impacts on competition in markets.”

Opening investigations is, of course, the easiest part of the process, and does not mean any competition issue exists. Competition investigations can start, stop, or spend a long time in between, and are often a black box to the outside world. Up until July 2017, little information appears to have been published unless a section 47 investigation resulted in litigation.

Fortunately, in July 2017, the Commission had announced that it intended publish a record of section 47 investigations on its website, to ensure the public and market were aware of investigations into potentially anti-competitive transactions.[viii] As a result, the Commission’s case register records outcomes for 11 section 47 investigations since the beginning of 2018.

A breakdown of them is instructive:

• In three cases, the Commission considered there was either no issue, or insufficient evidence to establish a competition issue: Bondor NZ/The Long Group, Bejier Ref AB/Heatcraft NZ/Kirby NZ, and Glenninburg Holdings/Wallace Group GP.
• In four cases, the Commission closed its investigation following a divestment or change in transaction. In Vero Insurance NZ/Tower Insurance, no further action was taken after Vero divested the 19.9% of Tower it had bought during its attempted takeover of Tower. In Fulton Hogan/Stevenson, no further action was taken after Fulton Hogan agreed not to acquire Stevenson’s Huntly quarry. In David Ferrier/Cavalier Wool Holdings no further action was taken after David Ferrier sold down his interest NZ Wool Dumping. In Datix/RL Solutions, no further action after Datix divested several customer contracts.
• In four cases, the Commission commenced proceedings. In Platinum Equity/OfficeMax Holdings, a settlement was reached after litigation was commenced. Platinum purchased OfficeMax but divested its WINC NZ business. In Wilson Parking NZ/Penrith Holdings, a settlement was reached after litigation was commenced. Wilson Parking offered an enforceable undertaking to divest the assets it had acquired. In First Gas/Gas Net, an agreed civil pecuniary penalty was imposed. And most recently, in Objective Corporation/Master Business Systems, a civil pecuniary penalty is to be imposed following settlement.

Without going into the merits of any of these individual cases, the outcomes overall suggest that the Commission was right to have some concerns but appears to have been able to address them. While headlines tend to focus on declines and penalty cases, divestures can equally represent a significant outcome for competition. In some cases, such as Platinum Equity/OfficeMax litigation, or the recent Ampol/Z Energy clearance, the entire existing New Zealand business is divested. It is also clear that some deals are ultimately stopped because of competition concerns, which can see investigations halted or clearance applications withdrawn.[ix]

This burst of section 47 activity may not be permanent. The Commission’s register indicates that while three section 47 investigations were commenced in mid-2020, there have been none commenced since August 2020 despite a veritable boom in merger activity. Instead, the 2021/2022 year appears to be one for the books in terms of merger clearances, with 15 applications decided in the first three quarters.

One possible explanation for this is that the Commission’s announced focus on non-notified mergers, followed up with investigations, has resulted in the pendulum swinging back towards parties seeking clearance. The increased probability of detection may have been what was missing, rather than the size of the penalties.

Conclusions

One busy year is not enough to draw firm conclusions, and we are working with small numbers in any event. But I would suggest three conclusions can be drawn, for what they are worth, from the data we have.

First, the Commission’s decision to regularly publish data on its merger work, and the decision to make section 47 information public on its register, assists in analysis and understanding of the Commission’s work in context. 10 years ago, a practitioner would need to rely on insider knowledge, intuition, or a lengthy series of OIA requests, to attempt to understand what was going on.

Second, the Minister was right that there was an increase in section 47 investigations, but it does not necessarily follow that a penalty increase was needed for that reason alone. If in the future there is a decrease in voluntary notifications, perhaps because of the cluster of blocked transactions, then the appropriate response might be more investigation. That may require resourcing and appropriate enforcement tools, rather than another increase in penalties.

Third, the Commission’s performance should be assessed in context. The Commission has not declined a clearance since Trade Me/Limelight, more than four years ago. But that does not mean that the Commission has not been busy enforcing New Zealand’s merger laws in other ways. Anyone viewing New Zealand as a soft touch could be in for a surprise.

And from 5 May, it is potentially a much larger one.

Ben Hamlin, Barrister.

Disclosure: Ben Hamlin was Deputy General Counsel, Competition, later Chief Legal Adviser, Competition, at the Commerce Commission between February 2017 and March 2022. His views are his own.

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[i] Commerce Amendment Bill, Third Reading, 17 March 2022.

[ii] See section 76 of the Competition and Consumer Act 2010 (Cth).

[iii]  The RBNZ Inflation Calculator indicates that a basket of goods worth $5 in Q2 1990, when the Commerce Amendment Act 1990 was passed, would be worth $9.60 in Q4 2021, the most recent available data.

[iv] See for example, A Labour Inspector v Southern Taxis Ltd [2021] NZCA 705 at [51].

[v]  Cabinet Paper “Review of Section 36 of the Commerce Act and Other Matters: Policy Decisions” (18 February 2020) at [56], available online here.

[vi] Merger determinations and enforcement statistics – December 2021, available here.

[vii] Commerce Commission “Commission releases 2018/19 priorities” (press release, 9 August 2018) available online here.

[viii] Dr Mark Berry, “Opening remarks” (Competition Matters 2017, Wellington, 21 July 2017).

[ix] For example, the recent Cargotec/Konecranes and Aon/Willis Towers Watson mergers were both cancelled because of competition concerns.

Are you underwhelmed? I'm not

It would be fair to say that the Commerce Commission's recent market study into the supermarkets left the commentariat distinctly underwhelmed: Bryce Edwards' Political Roundup had a useful summary of the immediate reactions and its title - 'Supermarkets win in the end' - captured the general drift (there are some follow-up reactions in his next few days' Roundups, here and here). 

That's partly the Commission's own doing. Its draft report had canvassed some radical proposals - potentially extending to "the structural separation of the major grocery retailers’ wholesale and retail businesses" (at 9.35.2) and "the facilitation of entry by an independent grocery wholesaler" (at 9.35.3), maybe even a government-owned or government-supported one (at 9.68). These were always unlikely to survive as final recommendations: the Commission had said (of structural separation) that it (and, I'd suggest, the other radical options) "would only be considered if other options were not feasible, had proved ineffective, or did not appear likely to improve competition within the desired timeframe" (at 9.64). 

But despite the implausibility of a KiwiShop anytime soon, in the meantime some people's hopes had got raised, and as a process issue the Commission might usefully have a think about giving a clearer steer in its draft reports on where it is thinking of landing along the final recommendation spectrum. It does no good to get a reputation for Crying Wolf.

All that said, I don't go along with the apparently prevalent perception that the Commission's recommendations were not proportionate to the issues involved. They correctly seized on the main point: the first best solution to inadequate competition is new entry - think 2Degrees shaking up Telecom (as was) and Vodafone, or Jetstar giving Air New Zealand the hurry-up -  and they identified a range of obstacles (planning laws, restrictive covenants, the overseas investment regime, the alcohol licensing regime) that could and should be cleared to make entry feasible. Good faith wholesaling to a new entrant is a useful starting point (I'd expected a bit more on access to a wholesale market, after seeing where the petrol market study had landed), and a code of conduct was always a certainty, following Australia's lead, to help address duopsony market power against suppliers. 

That package, and the threat of something heavier duty at a three year review if the shape of competition isn't looking better, looked to me to be an adequate policy combo. And I don't share the general pearl-clutching about its supposed timidity, for two reasons.

One is that I'm not convinced that there was such an enormous problem to start with. For all the jumping up and down about extortionate profits by the New Zealand supermarkets, the rate of return on the average level of capital employed in the New Zealand supermarket trade is not that different to the rate of return on the capital employed in the overseas supermarket game, as Figure 3.4 (below) of the market study showed. To explain this away, you either have to say an average is meaningless (no it isn't), or that all the overseas supermarket markets are rorts, too (no they aren't).

Return on capital employed is the best measure of potentially ineffective competition, but for what it's worth other measures of profitability (canvassed on pp60-64 of the report) showed the same thing: "Our analysis shows that profit margins for New Zealand’s major grocery retailers are broadly consistent with the sample of overseas grocery retailers" (p60).

The international price comparisons paint a darker picture, but even then it is not as black as the comparisons with the rest of the OECD would suggest. I like the general approach of benchmark comparators - countries that in some rough and ready way are 'like us' - and when the Commission did that exercise, it found (in Figure 3.13, shown below) that we still looked a bit on the expensive side, but not as obviously out of step as the whole-of-the-OECD comparison showed.

So my general reaction is that the scale of the proposed recommendations needs to be measured against the size of the competition problem, and it is too easy to get carried away about the size of the problem.

My second thought about the proportionality of the Commission's response is that they stayed on the correctly conservative side of respecting the incumbents' rights to earn a return on their investments. Some of the commentariat, on the other hand, would have happily embarked on extensive structural surgery, even though, as the Commission rightly said (on p404), "The lack of any essential facility or natural monopoly characteristic means that grocery wholesaling is not the type of industry ordinarily

regarded as potentially amenable to such intervention".

The reality is that the two supermarket chains rolled out national chains of stores, organised the suppliers, built the loyalty card schemes, and in general successfully managed to establish large, logistically complex, wholesale and retail businesses. We may dislike it that at least for now we are on the receiving end of a duopoly, as we were pre 2Degrees, for example, but let's face facts. The incumbents did the initial hard yards. It's in the nature of commercial affairs that, for a time, the first people to roll out the infrastructure will reap the gains: indeed, in some industries it's the prospect of early-mover superprofits that propels the investment in the first place, à la Schumpeter.

The best answer to this sort of situation is to help third and fourth players get into the game, especially when the first two have the advantage of Stiglerian barriers to entry: obstacles that new entrants have to surmount that the incumbents didn't (notably the limited availability of land zoned for supermarkets once the incumbents had got their share, and the restrictive and exclusive covenants inhibiting further grocery store development). Dismantle those, and then let's see what a Costco or an ALDI can do.

Reinventing the wheel?

In the armoury of regulatory interventions you might reach for to fix a market problem, I'd normally rank the Part 4 regime in our Commerce Act just above dosing with ivermectin and roughly on a par with sacrificing goats to Baal. I'd try everything else first.

But to my own surprise I'm beginning to wonder if it mightn't be a better answer to the Three Waters hoohah than the current "take the water assets away from councils and give them to four bigger entities with a convoluted governance structure".

There are various things going on in the water policy space, and no doubt conservation and Māori perspectives are at play, too. But if the big policy problem in water is (and I think it is) what economists like to call dynamic inefficiency - councils aren't minded, and/or able, to invest enough to keep the water assets in serviceable nick over the longer haul, hence iffy reservoir capacity (Auckland), poisonous water (Havelock North), pipes bursting in the CBD (Wellington) - then maybe it's time to deploy Part 4, or at least part of it, before creating whole new superstructures.

The bit of Part 4 that looks particularly fit for purpose is the 'information disclosure' regime. It's already been applied, for example, to electricity lines businesses: for lines businesses owned by local consumer trusts, who are in the same governance ballpark as water assets owned by councils, it's the only bit of Part 4 that typically applies (the rest of the lines businesses are required to disclose, too, but are also subject to a revenue control regime). Information disclosure can be a great way to surface whether an incumbent utility is not investing enough to keep the lights on, or the water flowing, over the long haul.

Here's an example of what's disclosed: it shows some of the 2020 data for Vector, which happens to be the lines network where we live. If you're interested in your own locality, head to this page, and click on your local network on the map. It'll bring up the option of downloading a pdf with all the data for your place. There's a lot more beyond the graphs shown below, and you'll also find that each lines company is compared with its peers.

Vector's lines and cables are in good nick. Only a very small proportion is 'Over generic age', and in any event Vector's planned spending on replacement is well above the minimum required to keep the network in good shape.

Some of its switching gear is getting a bit long in the tooth, but again Vector has it in hand and plans to spend well above the minimum required to keep them chugging along. From a dynamic efficiency point of view it's all good. 

You could easily imagine requiring all the water entities being asked to provide the corresponding data, which would stand a very good chance of zeroing in on the problem areas. Some of the councils, for example, are declining to join the proposed new four-entity regime because they say they're managing just fine, and that's a perfectly fair point to make: an information disclosure regime along these lines would prove their case.

And if there's a problem how would you go about fixing it? As it happens, we've got a worked example of that, too. It's  Aurora, which to give it its due is in the process of fixing things, but which was starting from a very bad place as far as maintenance of its lines network went. 

Aurora is the Dunedin Council owned network that serves Dunedin, central Otago, and Queenstown Lakes. As the Commerce Commission said here (p7) in March, "Aurora’s ageing network has been inadequately maintained due to underinvestment going back many years. As a result, it is providing an increasingly less reliable service to consumers. The average number and duration of outages has risen significantly over the past 10 years and would continue to worsen if action is not taken". Sound like the water problem? It does, doesn't it.

And the answer is a form of revenue control (Aurora is council owned, rather than consumer trust owned, so falls under the revenue control regime). The Commerce Commission has approved a 'customised price path' or CPP for Aurora, which will allow it to raise $563 million over the next five years to spend on bringing its network up to scratch. 

As the Commission said (p5), "Our decision on Aurora’s capital spending reflects our view that it has largely made the case for the increased investment". Because it's such a big ask starting from where they were, the price increases will be phased in (p5): "To help mitigate the impact of increased bills on consumers we have decided to cap Aurora’s total line charge revenue over the five-year CPP period. Annual increases will be limited to approximately 10% per year plus or minus any changes from the Consumer Price Index (CPI) forecasts we have used". Something similar might well be needed for the water entities most behind with their upkeep.

My question is: if we've already got a policy regime that looks pretty useful at diagnosis (information disclosure) and treatment (a costed and funded remediation programme) for electricity lines businesses (and gas pipelines, plus airports are under info disclosure), who do we need to re-invent the wheel for water?