European Union merger law

European Union merger law is a part of the law of the European Union which regulates whether firms can merge with one another and under what conditions. It is part of competition law and is designed to ensure that firms do not acquire such a degree of market power on the free market so as to harm the interests of consumers, the economy and society as a whole.

Mergers and acquisitions are regulated by competition laws because they may concentrate economic power in the hands of a smaller number of parties. Oversight by the European Union, the competition laws have been enacted under the Directive 2005/56/EC on Cross-border mergers and the Economic Concentration Regulation 139/2004, known as the "EUMR".^[1] The law requires that firms proposing to merge apply for prior approval from the Commission, specifically mergers that transcend national borders and with an annual turnover of the combined business exceeds a worldwide turnover of over EUR 5000 million and Community-wide turnover of over EUR 250 million must notify and be examined by the European Commission.^[2] Merger regulation thus involves predicting potential market conditions which would pertain after the merger. The standard set by the law is whether a combination would "significantly impede effective competition... in particular as a result of the creation or strengthening of a dominant position..."^[3]

One reason why businesses may be motivated to merge is in order to reduce the transaction costs of negotiating bilateral contracts.^[4] Another is to take advantage of increased economies of scale. However, increased market share and size may also increase market power, strengthening the negotiating position of the business. This is good for the firm, but can be bad for competitors and downstream entities (such as distributors or consumers). A monopoly is the most extreme case, where prices might be raised to the monopoly price instead of the lower equilibrium price. An oligopoly is another potentially undesirable situation in which limited competition may allow higher prices than a market with more participants.

Concentration

Under EC law, a concentration exists when a...

"change of control on a lasting basis results from (a) the merger of two or more previously independent undertakings... (b) the acquisition... if direct or indirect control of the whole or parts of one or more other undertakings." Art. 3(1), Regulation 139/2004, the European Community Merger Regulation

This usually means that one firm buys out the shares of another. The reasons for oversight of economic concentrations by the state are the same as the reasons to restrict firms who abuse a position of dominance, only that regulation of mergers and acquisitions attempts to deal with the problem before it arises, ex ante prevention of creating dominant firms. In the case of [T-102/96] Gencor Ltd v. Commission [1999] ECR II-753 the EU Court of First Instance wrote that merger control is there "to avoid the establishment of market structures which may create or strengthen a dominant position and not need to control directly possible abuses of dominant positions."

Significantly impeding effective competition

Prior to the implementation of Regulation 139/2004^[5] and the turn towards a more effects-based approach to EU competition law, EU merger control was governed by EEC Regulation 4064/89. Under EEC Regulation 4064/89^[6] (the 'old' regulation), a merger or concentration was prohibited if it would

"create or strengthen a dominant position as a result of which effective competition would significantly impeded".^[7]

The old substantive test is said to have encouraged two alternative interpretations of how to apply the test. The alternative interpretations suggest that, the presence of dominance alone is a sufficient condition to satisfy the dominance test and that as part of a two-tier test dominance is a necessary condition to satisfy before considering the dynamics of competition between the parties merging and the competitive characteristics of the market following the notification of a merger.^[8] The effective of the old "dominance test" increasingly began to be called into question with concerns regarding the issues of overenforcement and the false positives. The case of Airtours v Commission^[9] in 2002 served as the case that ultimately urged the Commission to recommend a change in EU merger regulation. The Commission prohibited the merger of Airtours and First Choice on the basis that it would create a collective dominant position in the market since there would be an incentive for the remaining firms in an oligopolistic market to restrict market capacity, leading to higher prices and increased profits as a result of subsequent market conditions following the merger. The oligopolists need not always "behave as if there were one or more explicit agreements between them." The Commission believed it was "sufficient that the merger makes it rational for the oligopolists...to act individually in ways which will substantially reduce competition between them."^[10] In the case of Airtours v Commission, the Court of First Instance annulled the Commission's decision to prohibit the Airtours-First Choice merger on the grounds that the Commission's interpretation of collective dominance was not informed by the widely recognised indicator of anti-competitive behaviour in an oligopolistic market - tacit collusion. The Airtours legal action created a significant level of uncertainty in EU merger law as a perceived gap had arisen with the law at the time - the gap of the non-collusive oligopoly. In response to the concerns raised regarding the "dominance test" and the non-collusive oligopoly gap in EU merger regulation, the European Council adopted Regulation 139/2004. Under Council (EC) Regulation 139/2004, a merger or concentration

"which would significantly impede effective competition, in the common market or in a substantial part of it, in particular as a result of the creation or strengthening of a dominant position, shall be declared incompatible with the common market".^[11]

Many commentators have commented on the need to create a new test. Legal academic Richard Whish described the EUMR of 2004 as "disarmingly simple",^[12] in that the 'dominance test' remains but the question posed by test is reversed. The new test, most commonly known as the 'SIEC' (significant impediment to effective competition) test, was employed to tackle the inefficiencies of the "dominance test" that mainly stemmed from the wording of the test and the prerequisite of an undertaking assuming a dominant position or the strengthening a dominant position in the market. The new 'SIEC' test is a reorganisation of the "dominance test" that eliminates "dominance" as a necessary requirement for SIEC and instead expresses SIEC as the single and sufficient condition for incompatibility with EU merger regulation.^[13] What amounts to a substantial lessening of, or significant impediment to competition is usually answered through empirical study. The market shares of the merging companies can be assessed and added, although this kind of analysis only gives rise to presumptions, not conclusions.^[14] The new test focuses on the subsequent changes to competition in a market following a merger, rather than whether the merged undertaking has acquire an excessive level of market power.

The effects-based approach of the 'SIEC' test allows the Commission to test for the possibly harmful effects of a merger on market competition without dismissing the efficiencies that may come about as a result of a merged entity using its dominant position in the market and economies of scale to reduce prices, increase innovation and increase consumer welfare. The "dominance test" would deem all mergers incompatible with the common market on the sole condition of dominance.^[15] Due to the wording of the new 'SIEC' test, efficiency defences are now allowed, in principle, as the focus on SIEC as opposed to dominance, means that a dominant merged entity will be able to argue the case for the merger on the grounds of increased consumer benefits, when applicable. However, from the 'SEIC' test's inception in 2004 to 2014 only a handful of petitioners argued the case for a merger using the efficiency defence, which could be due to the feelings that the defence of efficiency may signal weakness in the rest of the case for a merger.^[16] The 'SIEC' test set out to address the inefficiencies of the "dominance test", however, there has arguably been no radical change to the manner in which the Commission assesses merger but there is evidence to suggest that the Commission is moving towards focusing on the relevant market characteristics that are consistent with effects-based analysis of market competition.^[17]

What amounts to a substantial lessening of, or significant impediment to competition is usually answered through empirical study. The market shares of the merging companies can be assessed and added, although this kind of analysis only gives rise to presumptions, not conclusions.^[14] The Herfindahl-Hirschman Index is used to calculate the "density" of the market, or what concentration exists. Aside from the maths, it is important to consider the product in question and the rate of technical innovation in the market.^[18] A further problem of collective dominance, or oligopoly through "economic links"^[19] can arise, whereby the new market becomes more conducive to collusion. It is relevant how transparent a market is, because a more concentrated structure could mean firms can coordinate their behaviour more easily, whether firms can deploy deterrents and whether firms are safe from a reaction by their competitors and consumers.^[20] The entry of new firms to the market, and any barriers that they might encounter should be considered.^[21]

Exceptions

Firms who are engaged in a prima facie uncompetitive concentration may be able to show that their action nevertheless results in "technical and economic progress" mentioned in Art. 2(1) of the ECMR^[22] as the focus of the analysis is on whether the concentration results in an overall impediment to effective competition, described as an “effects based equilibrium approach.”^[23] “Technical and economic progress”, being a desirable effect on the market, will thus be accounted for in an assessment on whether the competitive equilibrium of the market will be positively or adversely affected by the proposed merger.

The Commission has published, as per Recital 29 of the ECMR, guidelines^[24] outlining the circumstances when economic efficiency might be factored into the assessment of whether a significant impediment to effective competition is present, such circumstances include whether a benefit has been produced to consumers,^[25] whether the benefit is a specific direct result of the merger^[26] and whether the benefit is verifiable and likely to materialise.^[27] Economic efficiency benefits were considered at great length by the Commission in UPS/TNT Express^[28] but ultimately it was concluded that a significant impediment to effective competition was still present even with the claimed efficiencies taken into account.

Another defence might be that a firm which is being taken over is about to fail or go insolvent, and taking it over leaves a no less competitive state than what would happen anyway.^[29][30] This was the case when the Commission considered the proposed acquisition of Shell’s Harburg refinery by Nynas in Nynas/Shell/Harburg Refinery^[31] and it accepted that the likely result of the merger not going ahead would be the closure of the refinery, thus the acquisition was allowed.

Mergers vertically in the market are rarely of concern, although in AOL/Time Warner^[32] the European Commission required that a joint venture with a competitor Bertelsmann be ceased beforehand. The EU authorities have also focussed lately on the effect of conglomerate mergers, where companies acquire a large portfolio of related products, though without necessarily dominant shares in any individual market.^[33]

Criticism

EU authorities' application of merger law in practice has been criticized for acting for protectionist reasons rather than sound economic reasons. For example, the EU blocked a proposed merger of General Electric and Honeywell^[34] on grounds of the possibility of "leverage" in other markets and "portfolio effects", even though United States regulators found that the merger would improve competition and reduce prices. Assistant Attorney General Charles James, along with a number of academics, called the EU's use of "portfolio effects" to protect competitors, rather than competition, "antithetical to the goals of antitrust law enforcement."^[35][36] United States Secretary of the Treasury Paul O'Neill called the rejection of the GE-Honeywell merger "off the wall" and complained of European Union regulators "They are the closest thing you can find to an autocratic organization that can successfully impose their will on things that one would think are outside their scope of attention."^[37]

Similar concerns were echoed by Australian industrial policy advocates when a change to its merger regulation was considered. It was argued that focusing on a “substantial lessening of competition” as opposed to market dominance might “obstruct mergers unnecessarily”,^[38] restrict the capacity of Australian companies to “compete effectively in the global marketplace”^[38] and that an intrusive merger policy might “hamper the growth of national industry.”^[39]

A report commissioned by the EU^[40] however recommended that the law be expanded to also include acquisitions of minority shareholdings even when such an acquisition might not result in the transfer of control to the purchasing firm.^[41] The current regulation addresses only concentrations, which require that the acquisition results in the control of one firm by another, leaving the current regulation unable to address any adverse effects of non-controlling acquisitions on competition, many of which might be similar to the effects as a result of acquisitions resulting in control.

The Commission suggested that where one firm has influence and voting rights over another then that firm can “limit the competitive strategies available to the target, thereby weakening it as a competitive force”.^[42] The example given is the proposed merger between Ryanair and Aer Lingus^[43] which would have resulted in Ryanair acquiring control, the proposal was blocked by the Commission on the basis that competition on a number of routes could have been harmed by Ryanair’s strengthened dominant position. However, the Commission was not able to examine the potentially harmful competitive effects of the existing minority shareholding in Aer Lingus owned by Ryanair despite the British National Competition Authorities being free to do so.

Notes

References

• Jones, Alison and Sufrin, Brenda (2005) EC Competition Law: Text, Cases and Materials, Oxford University Press, 2nd Ed. ISBN 0-19-926997-1
• Wilberforce, Richard (1966) The Law of Restrictive Practices and Monopolies, Sweet and Maxwell
• Whish, Richard (2003) Competition Law, 5th Ed. Lexis Nexis Butterworths, ISBN 0-406-95950-1