Mergers qua Competition Regime

1
Mergers qua Competition Regime
H.S. Chandhoke Partner, Luthra Luthra Law
Offices
2
Contents

• 1. Coverage
• 2. Mergers Basic Concepts
• 3. Rationale for Merger Regulation
• 4. Types of Mergers
• 5. Motivation for Mergers
• 6. Adverse Effects of Mergers
• 7. Facts and Figures
• 8.Cross Border Mergers

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Contents

• 9. Mergers in India
• 10. Merger Control Provisions in India
• 11. A Balancing Act
• 12. The Legal Framework
• 13. The Competition Act 2002
• 14. Decided Cases

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Coverage

• The three core areas covered in the Competition
  Law across the globe are-
• 1. Anti-competitive agreements
• 2. Abuse of Dominant Position and
• 3. Regulation of Combinations including mergers.
• The first two areas are prohibited ex post while
  the regulation of merger is generally ex-ante.

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Mergers Basic Concepts

• Merger - combination of two or more enterprises
  whereby the assets and liabilities of one are
  vested in the other, with the effect that the
  former enterprise loses its identity.
• Amalgamation combination of two corporate
  entities where the assets and liabilities of both
  are vested in a third entity, with the effect
  that both former entities lose their identities
  to form a new entity.

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Mergers Basic Concepts

• Competition Act 2002
• Section 2(a)
• Acquisition the acquiring, directly or
  indirectly of shares, voting rights, assets or
  control over management or assets, of another
  enterprise.

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Mergers Basic Concepts

• Section 2(h)
• Enterprise means a person who is engaged in
  any activity relating to production, storage,
  supply, distribution, acquisition or control of
  any goods, or the provision of services, or in
  investment or securities, either directly or
  indirectly, but does not include sovereign
  functions of the government.

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Basic concepts

• Combination includes
• Acquisition of control, shares, voting rights or
  assets by an acquirer of an enterprise section
  5(a)
• Acquiring of control by a person of an enterprise
  where the person already has control over another
  enterprise engaged in production, distribution
  and trading of similar or identical or
  substitutable goods/services
• Merger or amalgamation between or amongst
  enterprises

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Rationale

• The rationale for merger regulation is simple
  It is far better to prevent firms from gaining
  market power than to attempt to control market
  power once it exists.
• Effective merger policy requires a judgment
  concerning the impact of merger on competition
  before the merger has occurred.

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Rationale

• The whole philosophy is based on an ancient
  English Maxim Prevention in better than cure.
• It is better to prevent and prepare rather than
  to repent and repair Navjot Singh Sidhu

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Types of Mergers

• Horizontal between enterprises in the same
  product market and at the same level of the
  production or distribution cycle.
• Vertical between enterprises that operate at
  different levels of the production or
  distribution cycle.
• Conglomerate between enterprises operating in
  different markets.

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Horizontal and Vertical Mergers
Raw Material Producer/Supplier
Raw Material Producer/Supplier
Raw Material Producer/Supplier
Manufacturer
Manufacturer
Manufacturer
Wholesaler
Wholesaler
Wholesaler
Retailer
Retailer
Retailer
Consumer
Consumer
Consumer
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Motivation for Mergers

• To diversify the areas of activity and thereby to
  reduce business risks
• To achieve optimum size so as to reap the
  benefits of economy of scale
• To reduce the duplicate expenses and thereby to
  improve the profitability
• To serve the customer better

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Motivation for Mergers

• To have cohesiveness in control of the
  organisation
• To grow without any gestation period
• Inorganic growth is believed to be much faster
  compared to organic growth.

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Adverse Effects of Mergers

• Mergers especially horizontal reduces the number
  of players and consequently the competition in
  the market
• Mergers amongst rivals is invariably unfriendly
  to consumers
• Mergers often results in increased market share
  and thereby leads to dominance which makes the
  resultant enterprise complacent

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Adverse Effects of Mergers

• and thereby brings inefficiency in the
  organisation
• Mergers between healthy and unhealthy enterprises
  reduces the tax liability and thereby makes the
  States exchequer poor
• Mergers often fail to create harmonisation in
  human relation.

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Facts Figures on Mergers1

• Worldwide mergers and acquisitions in the first
  quarter of 2005 exceeded 589 billion.
• Combined with 670 billion in Q4 2004 that
  amounts to over 1.2 trillion over 6 months.
• 1 Source Thomson Financial Services

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Facts Figures on Mergers

• Asian MA in Q1 2005 amounted to 36 billion
  (rise of 32.9 over Q1 2004) consisting of a
  total of 1,355 transactions (a decline of 12.9
  from Q1 2004).
• South Korea ranked first in terms of transaction
  value while China ranked first in terms of number
  of transactions.

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Facts Figures on Mergers
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Facts Figures on Mergers - India

• Late 1980s 35 mergers.
• 1997 552 mergers.
• 2002 - 6.5 billion.
• 2003 - 3.7 billion. (Business Economy
  Magazine)
• The value of mergers in India more than doubled
  to 9.32 billion in 2004, from 4.4 billion in
  2003. (Bloomberg Feb 2005)

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Facts Figures on Mergers - India

• The first quarter of 2005 itself has seen MAs to
  the tune of over 3 billion. (Thomson Financial)
• According to PWC study which appeared in
  Financial Express of August 17, 2005, India
  recorded second highest growth rate in MA
  activities in the first half of 2005, second only
  to Japan.

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Facts Figures on Mergers Asia (ex Japan)
Q1 2005 Figures
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Cross Border Mergers1

• Worldwide Cross Border MAs represent a large
  portion of the total MAs amounting to 296
  billion in 2003, of which Indias participation
  amounted to 949 million (83 out of 4562 deals).
• World Investment Report 2004

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Cross Border Mergers

• The motivating factors for cross border MAs are
• Quickest way to grow
• Acquire tangible and intangible assets
• Restructure existing operations
• Exploit synergies
• Obtain strategic advantages

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Cross Border Mergers

• However, the overwhelming majority of the cross
  border MAs involve foreign firms acquiring
  Indian companies. In cases where such
  acquisitions involve no increase in economic
  efficiencies or production capacities, it raises
  the concern that such MAs simply shift ownership
  from domestic to foreign hands.
• Domestic consolidation of enterprises would help
  Indian enterprises achieve a better bargaining
  position and reverse the trend.

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Mergers in India

• From 1991 to date, mergers are not regulated
  from a competition perspective. The Asian
  Development Outlook 2005 mentions the impact of
  MAs in India. It indicates for example Coca
  Cola re-entered the Indian market in 1993 by
  acquiring Parle. Today it has 50 market share of
  the soda industry. Pepsi gained a major market
  presence by acquiring Duke in 1988, and now has
  48 market share of the soda industry.

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Mergers in India

• HLL has succeeded in enhancing its market share
  through a process of Mergers /Acquisitions
• Product 1992-93 1997-98
• Ice Cream 0.00 74.06
• Sauces,ketchups,jams 0.00 63.54
• Dental hygiene products 11.20 41.56
• Soaps 19.66 26.01
• Synthetic detergents 33.12 46.72
• Vanaspati 0.85 13.90

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Merger Control Provisions in India

• Pre 1991 Only the MRTP Act, 1969 and the
  Companies Act, 1956 had merger control
  provisions.
• Post 1991 The Companies Act, 1956 SEBI
  (Takeover) Guidelines, 1997 and the Competition
  Act, 2002 now form the backbone of merger control
  provisions in India.

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A Balancing Act

• Despite foreseeable advantages, mergers can have
  an adverse impact on public and consumer interest
  in terms of higher costs, increased political
  influence of merged entity and reduced efficiency
  owing to diversification into unrelated
  businesses.
• In dealing with mergers, Competition Law has to
  balance between encouraging competition and at
  the same time promoting economic efficiency.

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The Legal Framework

• 1. The Companies Act, 1956
• Sections 390 - 396A, 108A, 17, 319 and 42.
• 2. SEBI (Substantial Acquisition of Shares and
  Takeovers) Regulation, 1997
• 3. The Competition Act, 2002
• Sections 5 and 6 deal with Combination and
  Regulation of Combination respectively.

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Threshold Limits

• Where a merger proposal comes within the purview
  of the threshold limits stated under Section 5,
  notification thereof may be made to the CCI.
• The Act encompasses a voluntary pre-notification
  requirement for mergers above a certain threshold
  limit.

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Acquisition, Acquisition of Control or
Merger or Amalgamation

• By a Person
• The Resultant Entity must have
• (i) in India, assets valued at more than Rs.1000
  crores or turnover of more that Rs. 3000 crores
  or
• (ii) in India or outside India, assets valued at
  more than US 500 million or turnover of more
  than US 1.5 billion.

• By a Group
• The Resultant Entity must have
• (i) in India, assets valued at more than Rs.4000
  crores or turnover of more than Rs. 12,000
  crores or
• (ii) in India or outside India, assets valued at
  more than US 2 billion or turnover of more that
  US 6 billion.

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Group

• Group means two or more enterprises which,
  directly or indirectly, are in a position to
• (i) exercise twenty-six per cent, or more of
  the voting right in the other enterprise or
• (ii) appoint more than fifty percent, of the
  members of the board of directors in the other
  enterprise or
• (iii) control the management or affairs of the
  other enterprise.

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Control

• Control includes controlling the affairs or
  management by
• One or more enterprises, either jointly or
  singly, over another enterprise or group
• One or more groups, either jointly or singly,
  over another group or enterprise.

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Section 6

• Any combination entered into which causes or is
  likely to cause an appreciable adverse effect on
  competition within the relevant market section
  2(t) in India shall be void.
• A person entering into a combination may give
  notice to the CCI disclosing details of the
  combination within 7 days of (a) approval of the
  merger by the boards of

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Section 6

• the enterprises, or (b) execution of any
  agreement for acquisition referred to in 5(a) or
  acquiring of control.
• Exception Section 6 does not apply to share
  subscription or financing facility or any
  acquisition by a PFI, FII, bank or venture
  capital fund pursuant to any covenant of a loan
  agreement or investment agreement.

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Notification Requirements

• Pre-notification is compulsory in US and EU.
• In India, pre-notification is only voluntary.
• Considering the current phase of growth and
  consolidation of industry, it was decided against
  incorporating a compulsory notification
  requirement.
• Post- merger notification runs the risk of having
  to unscramble the merger which usually entails
  high social cost.

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Inquiry Section 20

• The CCI may inquire into whether a combination is
  likely to cause an appreciable adverse effect on
  competition based on its own knowledge or on
  information provided to it.
• However, the CCI cannot initiate an inquiry into
  any combination after the expiry of one year
  since that combination has taken effect.
• CCI shall inquire in cases where notice is given
  under section 6(2).

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Factors to be examined Section 20

• In order to determine whether a combination
  would have the effect of or is likely to have an
  appreciable adverse effect on competition, the
  CCI shall have due regard to the following
  factors
• a) actual and potential level of competition
  through imports in the market
• b) extent of barriers to entry in the market
• c)   level of combination in the market
• d) degree of countervailing power in the market

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Factors (cont.)

• e) likelihood that the combination would result
  in the parties to the combination being able to
  significantly and sustainably increase prices or
  profit margins
• f) extent of effective competition likely to
  sustain in a market
• g) extent to which substitutes are available or
  are likely to be available in the market

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Factors (cont.)

• h) market share, in the relevant market, of the
  persons or enterprises in a combination,
  individually and as a combination
• i) likelihood that the combination would result
  in the removal of a vigorous and effective
  competitor in the market
• j) nature and extent of vertical integration in
  the market
• k) possibility of falling business

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Factors (cont.)

• l) nature and extent of innovation
• m) relative advantage, by way of the contribution
  to the economic development by any combination
  having or likely to have appreciable adverse
  effect on competition
• n) whether the benefits of the combination
  outweigh the adverse impact of the combination,
  if any.

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Procedure for Investigation Section 29

• Where the CCI opines that a combination is likely
  to have an appreciable adverse effect on
  competition, it shall call upon the parties to
  respond within 30 days showing cause as to why an
  investigation should not be conducted

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Procedure (cont.)

• After receiving the responses, if the CCI is of
  the prima facie opinion that the combination is
  likely to have an appreciable adverse effect on
  competition it shall direct within 7 days that
  the details of such combination be published
  within 10 working days of such direction, in the
  manner prescribed

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Procedure (cont.)

• Objections to the combination are invited from
  the public within 15 days from the date of
  publication
• Within 15 days of receiving comments, the CCI may
  call for additional information from the parties
  to the combination, which is to be furnished
  within 15 days.
• After the receipt of all information, the CCI
  must come to a decision within a period of 45
  days.

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Orders Section 31

• The Commission has to pass final order within 90
  working days (subject to certain exception) from
  the date of publication, failing which the
  Merger is deemed to have been approved
• The Commission is vested with a power to approve
  the Merger, or approve with modifications, or to
  reject the merger

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Orders

• In case the modification suggested is agreed to
  by the parties, the merger is approved and in
  case modifications are not agreed to, the Merger
  is refused and the agreement will be declared
  void

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Orders modifying the Merger

• Divestment
• Requiring access to essential inputs/facilities
• Dismantling exclusive distribution agreements
• Removing no-competition clauses
• Imposing price caps or other restraints on prices
• Refrain from conduct inhibiting entry

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Penalty Section 44

• If any party to a combination makes a false
  statement or omits to state any material
  particular, such person is liable for a penalty
  between Rs. 50 lakhs and one crore.

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Usage

• Even though the factors and procedure contained
  in Competition law seem comprehensive, experience
  has shown authorities very rarely block proposed
  mergers.
• The European Commission has prohibited 19
  proposed mergers out of a total of 2827 notified
  (0.65) between 1990 and July 2005.

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Usage

• The Competition Commission of the UK since being
  set up in 2003 has found adverse competition
  effects in only 5 cases and prohibited only 3.
• The US Federal Trade Commission and Department of
  Justice combined challenged only 36 out of 1014
  mergers notified in 2003 leading to 12 consent
  orders and 16 abandoned transactions.

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Decided Cases

• FTC v. Staples Inc. 970 F.Supp. 1066 (DDC
  1997)
• In 1997, the two largest office superstore
  chains in US, Office Depot and Staples Inc.
  announced their agreement to merge. The Federal
  Trade Commission (FTC) opposed the merger on the
  grounds that it was likely to harm competition
  and lead to higher prices in the market for the
  sale of consumable office supplies sold through
  office superstores.

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FTC v Staples Inc. (cont.)

• The FTC argued that voluminous evidence
  structural, documentary and statistical
  supported the conclusion that the proposed merger
  would raise prices for office supplies.
• The relevant market in this case was held to be
  office superstores and that the merged entities
  would have a dominant market share between 45
  - 100 in many geographic markets.

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FTC v Staples Inc. (cont.)

• Office superstores were held to be different from
  other office supply retailers in terms of
  appearance, size, format, the number and variety
  of items offered, and the type of customers
  targeted.
• In the absence of a merger, the separate entities
  were competitors and would have targeted each
  others market and kept prices low.
• The efficiencies argued for were held not to be
  sufficient to offset price increase.

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Cases

• GE-Honeywell Case No. COMP/M.2220
• On October 22, 2000 a merger was announced
  between two American based companies General
  Electric and Honeywell.
• GE makes, sells, and services large aircraft
  engines. Honeywell makes small aircraft engines,
  avionics components, and non-avionics components,
  such as environmental control systems, wheels and
  brakes, and auxiliary power units.

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GE-Honeywell

• This was case of a conglomerate merger, where the
  only substantial horizontal overlap occurred in
  the supply of military helicopter engines and in
  repair and overhaul services for certain
  Honeywell aircraft engines.
• However each party was a leader in its respective
  market. At 42 billion it was the largest
  industrial merger in history.

57
GE-Honeywell

• The USDOJ cleared the proposed merger on the
  condition that GE divest Honeywells helicopter
  engine business and to license a new competitor
  to maintain and repair certain Honeywell engines.
• Due to the size of GE and Honeywells European
  sales, the merger had to be approved by the
  European Commission (EC) as well.

58
GE-Honeywell

• The EC found that GE had a dominant position in
  the aircrafts engine market while Honeywell had a
  dominant position in the avionics and
  non-avionics sectors.
• These products being complementary to each other,
  the EC held that the merger would allow the new
  entity to bundle their products, giving it an
  advantage over competitors.

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GE-Honeywell

• This advantage would lead to the exit of rivals
  and ultimately the elimination of competition
  altogether. The EC thus blocked the merger.

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Selected Reading

• Antitrust Law Developments, American Bar
  Association (ABA), 5th ed., ABA Section of
  Antitrust Law.
• Gellhorn, Ernest, Kovacic, William E., and
  Calkins, Stephen, Antitrust Law and Economics in
  a nut shell, 2004, West Publishing Co., MN.
• Goetz, Charles J., McChesney, Fred S., Antitrust
  Law Interpretation and Implementation, 2002,
  Mathew Bender Co, Lexis Nexis, NJ.
• Whish, Richard, Competition Law, 5th ed, 2003,
  Butterworths.