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Mergers qua Competition Regime

H.S. ChandhokePartner, Luthra & Luthra Law Offices

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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; and3. 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 2002Section 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 State’s 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 M&A 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 1980’s – 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 M&As 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 M&A 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 M&As represent a large portion of the total M&As amounting to $296 billion in 2003, of which India’s 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 M&As 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 M&As 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 M&As 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 M&As 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 1997-98Ice Cream 0.00 74.06Sauces,ketchups,jams 0.00 63.54Dental hygiene products 11.20

41.56Soaps 19.66 26.01Synthetic detergents 33.12 46.72Vanaspati 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, 1956Sections 390 - 396A, 108A, 17, 319 and 42.

2. SEBI (Substantial Acquisition of Shares and Takeovers) Regulation, 1997

3. The Competition Act, 2002Sections 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 GroupThe 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.

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GE-Honeywell

The USDOJ cleared the proposed merger on the condition that GE divest Honeywell’s helicopter engine business and to license a new competitor to maintain and repair certain Honeywell engines.

Due to the size of GE and Honeywell’s European sales, the merger had to be approved by the European Commission (EC) as well.

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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.