How to (almost) gut an agency – the final twist in the maize seeds case?

By Patrick Smith

On 18 December 2013, the Constitutional Court of South Africa (“Constitutional Court”) handed down its decision in an appeal by the Competition Commission (“Commission”) against an unprecedented costs order imposed by the Competition Appeal Court (“CAC”).  The costs order related to the CAC’s decision to overturn the decisions of the Commission and the Competition Tribunal (“Tribunal”) to prohibit the merger between Pioneer Hi-Bred International and Pannar Seeds.

The Commission had originally prohibited the proposed merger on 7 December 2010,[1] following a three-month investigation.  In the Commission’s assessment, the transaction amounted to a 3 to 2 concentration amongst producers of seeds for the staple food in South Africa, if not much of sub-Saharan Africa.  Quite apart from the substance, this sector fell squarely within the Commission’s prioritisation programme, and so was always likely to receive close scrutiny.[2]  On the Commission’s assessment, the transaction would give rise to significant unilateral effects, removing an important competitor from the market.  The Commission considered the merging parties’ submissions that the transaction would lead to efficiencies from a combination of the two parties’ breeding programmes, but found the claimed benefits unconvincing and unlikely to outweigh the anti-competitive harm.

Following an extensive discovery process and a three-week hearing involving nine witnesses, the Tribunal also decided to prohibit the merger, on 9 December 2011.[3]  The Tribunal considered the potential for anti-competitive effects (concluding that the parties were close and effective competitors, and that the transaction would accordingly give rise to very significant anticompetitive effects),[4] and the likelihood of significant efficiencies (concluding that the Parties’ assumptions were “either grossly exaggerated or totally unrealistic”, and that any potential merger-specific efficiencies would lie beyond a 5 year time horizon)[5].  Despite the parties’ characterisation of the industry as a “dynamic innovation market”, maize seeds improve by 1-2% per annum (not exactly Moore’s law)[6] and the wide variety of different growing conditions (and the use of seeds adapted for each region), mean that any particular innovation is unlikely to be universally applied; the Tribunal highlighted the need to account for anticipated non-merger specific innovation as a benchmark against which the parties’ claims should be measured.

Notably, the Tribunal focussed substantial attention on assessing the relevant counterfactual against which the merger should be assessed.  While it was common cause that the target firm did not meet the requirements of the failing firm defence, in the course of the Tribunal hearing the parties had argued that the target firm, Pannar, would decline as a competitive force, most rapidly in relation to one specific product area (so-called irrigated region hybrids), but also more generally across its whole product range.  Considering local and international approaches to the counterfactual, the Tribunal found that there was no compelling evidence of the certain decline of the target firm (which was still the market leader in relation to the irrigated region hybrids), and concluded that there was no reason not to accept the status quo as the relevant counterfactual.

Following two days of oral argument, the CAC overturned the Tribunal’s prohibition, instead deciding on 28 May 2012[7] that the merger should be allowed subject to conditions, including the imposition of restrictions on price increases on existing Pannar varieties to the level of consumer price inflation for three years, and agreeing to license a list of Pannar varieties for breeding by third parties.  The CAC’s reasoning was based on an assumption that the decline of the target firm was “inevitable”[8] albeit uncertain in its timing, although it was again universally accepted that Pannar failed to meet the requirements of a failing firm.  On that assumption, the CAC appeared to reverse the onus that would have applied with a failing firm defence, and stated that the Commission[9] had failed to establish the likelihood of an alternative transaction that might preserve Pannar’s assets, in the event of a prohibition.  The CAC placed an unusually heavy weight on the interests of private shareholders,[10] as opposed to consumers, which is in distinction to the strict requirements of the failing firm defence, as applied internationally.[11]  The CAC ultimately concluded that the relevant counterfactual was the continued decline, eventual demise and exit by Pannar,[12] and against that benchmark, approved the transaction, subject to conditions.

It is unfortunate that the Supreme Court of Appeal denied the Commission leave to appeal on the substance, as the CAC’s approach to the counterfactual has created some uncertainty that may need to be resolved in another case.  In any event, the Constitutional Court was only asked to consider the CAC’s costs award.[13]

The CAC had awarded costs against the Commission, not only in respect of the CAC proceedings, but also those before the Tribunal.  The Constitutional Court first clarified that the Tribunal has no power to award costs against the Commission (thereby distinguishing the Commission, as a “party”, from a private “complainant” in Tribunal proceedings).[14]  Furthermore, the Constitutional Court determined that the CAC is similarly unable to award costs in relation to Tribunal proceedings.[15]  Finally, while the CAC has discretion to award costs against the Commission in respect of CAC proceedings, it must properly exercise this discretion.[16]  The Constitutional Court noted that while the “Unreasonable, frivolous or vexatious pursuit of a particular stance” may justify a costs order against the Commission, the vigorous pursuit of its case would not.  The Court highlighted the distinction between an ordinary civil litigant and the Commission, which is required to pursue its statutory mandate vigorously, often where there is no opposing party or amicus.  Ultimately, the Constitutional Court concluded that the lack of reasoning behind the costs award, and the lack of any evidence of “mala fides, irregularity, or unreasonable conduct” by the Commission meant that the costs order had to be set aside.

This is clearly an important result for the Commission’s ongoing activities.  The Commission had argued before the Constitutional Court that a costs order would have a serious effect on its budget and its stance in defending similar investigations and findings before the CAC.  Ideally, competition enforcement should aim to strike a balance between sufficiently robust enforcement to achieve policy objectives and the need to avoid imposing undue or disproportionate costs on the businesses that ultimately drive competition, growth and job creation.  Particularly in a developing country context, a certain degree of prioritisation can be helpful in building institutional capability and making the most effective use of limited resources, as well as minimising the burden of investigations.  By focussing the most resources and attention on those cases most likely to cause harm, an agency might maximise the benefits of enforcement, while minimising the potential for any inefficiency caused by the investigation process.

In this case, while the CAC took a different view from the Tribunal (and the Commission), it would be difficult to label the Tribunal’s decision (and hence the Commission’s defence at the CAC) as unreasonable or vexatious.  In a nutshell, this was a 3 to 2 combination between direct (“horizontal”)^[17] competitors in a priority sector, in an industry that, while increasingly influenced by innovation, is slow moving in comparison with “innovation markets” such as those in the ICT sector.

South African merger control is not characterised by many prohibition decisions.  Amongst intermediate and large mergers, this is the most recent prohibition decision issued by the Tribunal.  There have been around 500 decisions since the previous prohibition, Telkom/BCX in August 2007.^[18]  Few prohibitions may well point to the outstanding deterrent effect of the Commission’s historical enforcement efforts, but it seems a stretch to consider that the Commission’s (albeit vigorous) defence of the only large/intermediate prohibition decision by the Tribunal in the past 6 years is an indication of a vexatious or overly aggressive approach.

While the Commission will no doubt be heartened by this decision, it will be interesting to see whether the clarifications provided by the Constitutional Court will have any bearing on the Commission’s stance on contentious matters before the CAC in future, in particular those involving more complex theories of harm.  Arguably more important will be the anticipated clarification of the approach to mergers involving declining firms in the light of the CAC’s approach to the counterfactual.