On 28 May, Europe’s General Court handed down a landmark ruling, comprehensively and emphatically upholding an appeal brought by CK Hutchison Holdings ('CK Hutchison') against the European Commission’s ('the Commission') prohibition of the proposed merger of its UK mobile subsidiary, Three UK, with rival company 'O2 UK' (owned by Telefónica).
An exceptionally strong five-judge bench of the Court, including the President and several judges with a competition law background, has handed down a clear and comprehensive re-statement of EU merger control law.
The Court’s ruling is the first judgment to address the legal test of 'significant impediment to effective competition' or 'SIEC' under the EU merger regulation (EUMR) introduced in 2004 and the Commission’s horizontal merger guidelines, and is therefore highly significant for European merger control across all sectors of the economy.
Many lawyers practising in the field of merger control have been concerned for a number of years that the way in which the Commission has applied key economic concepts and its approach to evidence has conferred too much discretion on the authority.
In the view of many, the Commission’s approach made it impossible, in any practical sense, to distinguish a clear test dividing those mergers which give rise to competition concerns from mergers which are not problematic.
Adding to this sense of unease was a view that the Commission’s enforcement stance had become stricter in recent years, without any legal authority. Although few mergers are ultimately blocked, the Commission has asserted the power to demand remedies in circumstances where many lawyers believe it had no legal right to do so.
The Court’s ruling is a major reset in this respect. The Court found in favour of CK Hutchison on each substantive legal ground raised in its appeal, holding that the Commission made several errors of law and fact in its assessment of the effects of the proposed merger relating to:
- prices and the quality of services for consumers;
- network investments; and
- wholesale services.
The ruling will require the Commission to reconsider its practices, approach to economic modelling and analysis and evidence gathering under the EUMR. In future, the Commission will be expected to adduce more compelling evidence before blocking – or seeking remedies – in other mergers in concentrated markets.
In the discussion below, the team which represented CK Hutchison throughout the course of the merger proceedings before the Commission and the Court offers its initial reflections on some of the key wider implications of the judgment for the EU’s system of merger control.
1. The SIEC test did not lower the threshold for Commission intervention
In an important aspect of its ruling, the Court found that the Commission did not satisfy the requisite legal standard to establish a SIEC.
The Court held that the changes which were made to the EUMR in 2004 were not intended to lower the threshold for Commission intervention in mergers. The Court found in this respect that the EUMR must be interpreted as allowing the Commission to intervene in concentrations in concentrated markets only where it can demonstrate merger effects that are equivalent to those resulting from the creation or strengthening of a dominant position.
The Court clarified that the standard to establish 'non-coordinated effects on an oligopolistic market is not substantially different from that applicable in order to establish coordinated effects' (as set out in the Court’s Airtours judgment). The Court furthermore reiterated that it is not – in its interpretation of the EUMR – bound by the Commission’s horizontal merger guidelines.
The Court held, in relation to the standard of proof for finding a SIEC in complex matters where the Commission relies on prospective and uncertain chains of causation, that the Commission has to produce sufficient evidence to demonstrate with a strong probability the existence of a SIEC.
Throughout its Decision, the Commission had not done enough to examine the real probability (as opposed to theoretical possibility) of any competitive harm from the merger. This was a fundamental flaw in the Commission’s decision that affected all aspects of its reasoning.
The Court’s re-emphasis of the standard of proof that the Commission is required to meet will be welcomed by all companies discussing a proposed merger with the Commission.
2. The Court resets the standard of intervention based on the SIEC test
In order to demonstrate an effect on prices and quality for consumers, the Commission had constructed an argument based on three key elements, which it derived from its own horizontal merger guidelines:
- it classified Three as an 'important competitive force' (ICF) – in other words, as a company which was particularly important for the competitive process and whose removal as a result of the merger would therefore be damaging to competition in the market as a whole;
- it assessed the merging parties – Three and O2 – as being 'close competitors' and asserted that the removal of this close competition as a result of the merger would significantly reduce competition in the market overall; and
- a quantitative economic analysis, which the Commission said demonstrated that prices for UK consumers would rise following the merger.
These theories, which sound somewhat technical at first sight, have in practice become the core element of the Commission’s finding of a SIEC in many cases. Before the Court’s ruling, these were 'self-made' tests that the Commission set for itself and then effectively marked its own homework.
Moreover, it has not been clear whether any of these points by themselves could amount to a 'significant' impediment to competition, sufficient to prohibit a merger or how the Commission should examine the overall effects of the merger in line with the 'significance' test in the EUMR.
The Court found that the Commission’s assessment of each of these concepts was vitiated by several errors of law and of assessment and thus failed to establish a SIEC.
Important competitive force
The Court held that the Commission had not established that Three was an ICF, the elimination of which would lead to a reduction in competitive pressure sufficient to establish the existence of a SIEC.
By confusing the concepts of 'SIEC' (article 2(3) EUMR), 'elimination of an important competitive constraint' (recital 25 EUMR), and 'elimination of an important competitive force' (horizontal merger guidelines) in its decision, the Commission had considerably broadened the scope of article 2(3) EUMR since any elimination of an ICF would amount to the elimination of an important competitive constraint which, in turn, would justify a SIEC finding.
In particular, the Commission made an error of law and an error of assessment in finding that an ICF does not need to stand out from its competitors in terms of its impact on competition, particularly in so far as such a position would allow the Commission to treat as an ICF any undertaking in a concentrated market exerting competitive pressure.
This would amount to a de facto power for the Commission to prohibit any horizontal merger in a concentrated market. This was not what the law provides in the EUMR and would also be a breach of the principle of legal certainty.
The Court found that the Commission had not provided evidence that Three was an ICF under the Court’s interpretation of the test. The evidence that the Commission sought to rely on, relating to the proportion of new customers won by Three, was not compelling or consistent with other merger transactions that the Commission had cleared in the past.
Other evidence regarding Three’s behaviour in the market was criticised as 'merely anecdotal'.
Closeness of competition
The Court found that the Commission’s analysis of 'closeness of competition' in the decision was focused on showing that Three and O2 were 'close competitors' rather than particularly 'close competitors', noting the Commission’s assertion that all four operators in the UK market 'compete closely'.
The Court resoundingly declared that this is not good enough. If the Commission wants to rely on 'closeness of competition', it must have robust evidence that merging parties are particularly close competitors.
Again, the Court was concerned that otherwise, the Commission could, as a matter of principle, prohibit any merger resulting in a reduction from four to three operators.
Furthermore, the Court criticised, in particular, the Commission’s reliance on a survey with a small sample of approximately 100 users for the calculation of diversion ratios, in contrast to the ratios calculated by the applicant that were based on 200,000 observations.
The Commission also applied an economic analysis known as the upward price pressure (UPP) test, which was originally developed in the US and has been applied by many merger control authorities, including in the EU.
One key criticism that has been applied to the use of this test is that it always predicts a price increase for any horizontal merger.
However, merger authorities, including the European Commission, have been reluctant to specify any threshold which would indicate which mergers are, and are not, anti-competitive under this test.
The Court found that the Commission had not demonstrated that the quantified price increase revealed by the UPP analysis in this case would be 'significant'. The Court clarified that this does not mean there is a 'de minimis' rule or 'safe harbour' threshold for possible price increases, but that the Commission must establish the increase with a sufficiently high degree of probability.
Crucially, the Court discarded the Commission’s UPP analysis because it did not account for all the relevant factors that affect prices, in particular 'standard efficiencies' that can be expected to arise from the merger.
The Commission has routinely rejected parties’ claims for merger efficiencies in the past (even if this, itself, has been a highly controversial stance) on the basis that the 'burden of proof' is on the parties in respect of efficiency claims.
However, the Court found that this was not a good reason to exclude 'standard efficiencies' from a pricing analysis. In questioning the robustness of the Commission’s quantitative analysis, the Court referred to a paper published by the former Chief Economist of the Commission.
3. Lack of any overall SIEC assessment
The Court found that the Decision – despite being nearly thousand pages long – lacked any overall assessment of whether the merger would lead to non-coordinated effects.
Instead, the decision was 'limited to a cursory reference to the body of evidence and circumstances concerning, in particular, the elimination of an important competitive force by the concentration, the closeness of competition and the large market share of the merged entity'.
The Court went on to state that '[i]rrespective of the probative value of that body of evidence and circumstances, it must be stated that the Commission did not at any point specify in the contested decision whether the non-coordinated effects identified would be ‘significant’ or would result in the present case in a significant impediment to effective competition, as it asserts in recital 1227 of the contested decision'.
The Commission’s failure to conduct any overall assessment is a fundamental flaw that affects the Commission’s entire SIEC analysis.
4. The Court reminded the Commission to protect competition, not competitors
The Commission also blocked the Three/O2 merger on the basis of a highly unusual theory of competitive harm relating to the effects of the merger on network sharing partners.
Network sharing agreements are common in the mobile communications industry as a means of efficiently sharing the costs of network roll-out and maintenance. The Court found that, here too, the Commission had failed to substantiate its position.
Key takeaways from the Court’s ruling are that:
- The Commission has a particularly high burden of proof and risks facing heightened scrutiny from the EU judiciary where it relies on novel theories of harm, such as the network theory of harm in the present case. This aspect of the ruling will have wider implications for other novel theories that the Commission is developing in other sectors such as its controversial 'innovation theory of harm' in pharmaceutical and digital markets.
- The Commission failed to assess whether the effects it described were truly potentially negative effects on the services and network quality offered by the merged entity and the market overall, or rather were negative for the parties’ competitors because they would face greater competition from a better resourced competitor. In this regard, the Court reminded the Commission that 'EU competition rules are primarily intended to protect the competitive process as such, and not competitors … [and] the fact that a concentration affects competitors is not in itself a problem. In particular, the fact that rivals may be harmed because a merger creates efficiencies cannot in itself give rise to competition concerns'.
- The Commission should have taken account of a longer time frame for its assessment of dynamic merger effects, commensurate to the long-term investment needed in the telecommunications sector. The Court found that in the more distant future the merged entity would unlikely remain part of both network sharing agreements, and therefore found the Commission’s concerns based on transparency would be unlikely to materialise in practice.
The Court’s ruling undoubtedly marks a major reset for the Commission’s approach to assessing potential harm to competition from mergers not involving dominance.
The Court, with a very strong five-judge bench, has handed down a clear and comprehensive re-statement of the law that the Commission is obliged to follow. The Commission has been told – in no uncertain terms – that its approach in recent years was not in accordance with the EUMR.
It is to be hoped that the Commission will respond by asking itself some fundamental questions about the way in which it approaches merger control assessments. Rather than sending ever longer requests for information and running ever more complicated economic models, the Commission may be better served by bringing focus and a more critical assessment to the issues.
Many transactions that might not have been pursued at all, or which could only have been contemplated with synergy destroying remedies, will now likely be re-evaluated in the light of the correct legal standard which the Court has elaborated in its ruling. This will be of particular importance in the telecommunications industry, in which the Commission’s recent approach has acted as a brake on consolidation.
The judgment can also be expected to have a disciplining effect on the Commission’s recent pursuit of innovation and other novel theories of harm, particularly in digital markets.
There is no doubt that the Court has sent a clear message to the Commission that it will not hesitate to intervene where the Commission exceeds the limits of the legal test of the EUMR or fails to satisfy the requisite standard of proof.
* * *
Freshfields advised CK Hutchison from pre-signing negotiations in 2014, through an extended Phase II merger control review and ultimately to the successful annulment action at the General Court. The Freshfields appeal team, based in Brussels and London, was led by partners Thomas Wessely, James Aitken, Michele Davis, Onno Brouwer, and counsel Angeline Woods* and was supported by a core team of associates including Imogen Ditchfield, Amaryllis Müller, Susannah Prichard, Maija Hall, Martin Dickson and Koo Asakura. The Freshfields team was supported by Brian Kennelly QC and a team from Frontier Economics led by Zoltan Biro and David Foster.
The CK Hutchison in-house legal team was led by Lorelei Fleming (General Counsel, Europe), supported by James Godden (Deputy Director, Competition and Regulation - Europe).
Freshfields advised the applicants in the only two successful appeals against EU merger prohibitions in the last 18 years. This judgment marks only the fifth time in the history of the EUMR that a prohibition has been overturned, following Freshfields advising UPS last year on its successful annulment action against the Commission’s prohibition of it acquiring TNT. Today’s victory adds to a series of significant successes for Freshfields in merger litigation, following the landmark victory in the United States on behalf of Evonik against the FTC earlier this year.
* Angeline Woods is now Legal Director, Antitrust and EU Affairs at Uber.
The mere effect of reducing competitive pressure on the remaining competitors is not, in principle, sufficient in itself to demonstrate a significant impediment to effective competition in the context of a theory of harm based on non-coordinated effects.