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Predatory buying to corner a market: ACCC v Cement Australia

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Information about Predatory buying to corner a market: ACCC v Cement Australia
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Published on March 4, 2014

Author: dr_martyn_taylor

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Case note for Australian Journal of Competition & Consumer Law (AJCCL) – 1 March 2014 on Australian Competition and Consumer Commission v Cement Australia Pty Ltd [2013] FCA 909
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Case note for Australian Journal of Competition & Consumer Law (AJCCL) – 1 March 2014 Predatory buying to corner a market: ACCC v Cement Australia Dr Martyn Taylor (Partner) and Claire Forster (Senior Associate), Norton Rose Fulbright Abstract The case Australian Competition and Consumer Commission v Cement Australia Pty Ltd [2013] FCA 909 involved the alleged use of a predatory buying strategy to ‘corner the market’ in the supply of flyash in south-east Queensland. This commentary provides an overview of that decision and the reasoning of Justice Greenwood of the Federal Court of Australia. The Australian Competition and Consumer Commission (ACCC) was not successful in establishing a contravention of the misuse of market power provisions in section 46 of the Competition and Consumer Act 2010 (Cth) (Act). However, the ACCC was successful in establishing that certain contractual provisions had the purpose of substantially lessening competition in contravention of section 45 of the Act. 1 Background and allegations In September 2008, the ACCC filed proceedings against Cement Australia Pty Ltd, Pozzolanic Enterprises Pty Ltd and two related companies (collectively, Cement Australia) in the Federal Court of Australia in Brisbane. The case was heard during 2010 and 2011. The ACCC pleaded that Cement Australia had entered into or amended long-term contracts with certain power stations located in south east Queensland between 2001 and 2006. These contracts contained provisions under which Cement Australia was entitled to acquire virtually all of the unprocessed fly ash available in that region. Flyash is a byproduct of burning black coal at electricity generating power stations. When of a suitable quality, flyash can be used as a cheap partial substitute for cement in ready-mix concrete. The ACCC alleged (among other things) that Cement Australia had no commercial need for the contracted volume of flyash as that volume substantially exceeded the demand of downstream customers. The ACCC alleged that Cement Australia was engaging in a predatory buying strategy in contravention of section 46 of the Act to foreclose competitors and, in effect, ‘corner the market’. The ACCC also alleged that provisions in the relevant contracts had the purpose or likely effect of substantially lessening competition in contravention of section 45. The case involved six primary and separate contended conduct contraventions against Cement Australia. The ACCC also pursued two executives who were involved in the conduct. On 10 September 2013, Justice Greenwood of the Federal Court of Australia delivered a detailed judgment of nearly one thousand pages. 2 Market definition was not disputed In a relatively straightforward analysis, Justice Greenwood identified two relevant markets:  1 an upstream market for the supply and acquisition of unprocessed flyash throughout south east Queensland from power stations located in that region (upstream market);1 and Australian Competition and Consumer Commission v Cement Australia Pty Ltd [2013] FCA 909, at [1781]. APAC-#21911909-v1 1 © Norton Rose Fulbright Australia

Case note for Australian Journal of Competition & Consumer Law (AJCCL) – 1 March 2014  a downstream market for the supply and acquisition of concrete grade flyash in south east Queensland and immediately adjacent areas of New South Wales (downstream market).2 In the upstream market, Cement Australia was an acquirer of unprocessed flyash from power stations. In the downstream market, Cement Australia was a supplier of (processed) concrete grade flyash, primarily to CSR, Pioneer and Boral. In undertaking his analysis, Justice Greenwood relied on expert evidence provided by two consulting economists Gregory Houston (for the ACCC) and Professor George Hay (for Cement Australia). There was no disagreement between the two economists on these market definitions. 3 Cement Australia had substantial market power Justice Greenwood held that Cement Australia did have a substantial degree of power in the downstream market, as a supplier of concrete grade flyash during the relevant period, for the purposes of section 46 of the Act. 3 Relevant factors in His Honour’s reasoning included that Cement Australia was able to acquire “all or virtually all of the concrete-grade flyash available” in the upstream market and was a “virtual single supplier” in the downstream market by September 2002.4 Cement Australia’s distribution and storage system was also highly integrated and difficult for a competitor to replicate. The extent of Cement Australia’s control made it “virtually or practically impossible for a potential entrant to compete”. Cement Australia disputed that it had such power. Cement Australia contended that, while it held a high market share arising from its entitlement to virtually all of the concrete-grade flyash under its power station contracts, there was no guarantee that such contracts would be renewed. Cement Australia identified that a joint venture company involving its largest customers was a competing bidder during the period. Accordingly, Cement Australia argued that uncertainty in the continuity of its contracts negated its market power. Justice Greenwood accepted part of Cement Australia’s argument and indicated that “uncertainty over an imminent horizon in the continuity of a firm’s contractual rights to an essential input influences the answer to the question of whether the firm continues to enjoy market power during the period leading up to the imminent resolution of the uncertainty”.5 Accordingly, uncertainty was regarded as a relevant factor when determining the extent to which market power flows from contractual rights. However, His Honour indicated that the “extent of the vulnerability” of the relevant contracts is critical in that analysis and is a matter of degree based on the particular facts.6 His Honour reasoned that Cement Australia’s vulnerability under its contracts was not sufficient to extinguish the substantial market power that arose from those contracts and other relevant factors.7 His Honour also considered whether or not the countervailing power of Cement Australia’s customers was sufficient to negate its market power, noting that three customers constituted 72% of Cement Australia’s sales. His Honour reasoned that the characterising features of the market that gave rise to the substantial degree of market power remained, irrespective of the degree of concentration in flyash sales to those customers. 8 2 3 4 5 6 7 8 Ibid at [1834]. Ibid at [1892]. Ibid at [1835]. Ibid at [1846]. Ibid at [1848] and [1849]. Ibid at [1883]. Ibid at [1891]. APAC-#21911909-v1 2 © Norton Rose Fulbright Australia

Case note for Australian Journal of Competition & Consumer Law (AJCCL) – 1 March 2014 4 The legal test for taking advantage Justice Greenwood held that Cement Australia did not take advantage of its substantial degree of power in the downstream market for the purposes of section 46. Accordingly, the ACCC’s various causes of action under section 46 all failed. In answering this question, His Honour stated that he was applying the narrower “could” test for taking advantage as applied by the majority of the High Court of Australia in Rural Press Ltd v Australian Competition and Consumer Commission (2003) 216 CLR 53, as subsequently applied by the majority of the Full Federal Court in Seven Network Ltd v News Ltd (2009) 182 FCR 160. Justice Greenwood held that the key question was whether a firm profitably could have engaged in the conduct in question in the absence of a substantial degree of power in the relevant market. In applying this question, His Honour indicated that he would consider whether a hypothetical profit maximising firm in a workably competitive market (hence with all aspects or sources of substantial market power stripped away) could, in a commercial sense, profitably engage in the conduct in question when acting for those legitimate business reasons.9 His Honour indicated that this test is objective but takes into account the legitimate business reasons actually advanced by the respondent.10 His Honour also indicated that the conduct to be assessed is very particular conduct, namely assessing whether the acquisition of the relevant input was profitable on the terms upon which it was actually contracted.11 Specifically, His Honour reasoned that if it were demonstrated that Cement Australia, as a profit maximising firm operating in a workably competitive market, could in a commercial sense have profitably engaged in the conduct in question with the commercial rationale it had identified, then Cement Australia had not taken advantage of its market power. 12 In effect, Cement Australia only needed to identify one legitimate reason for its behaviour that it could establish was profitable. Importantly, Justice Greenwood was required to make his decision under a formulation of section 46 that preceded the enactment of the new ‘taking advantage’ factors into section 46(6A). This issue is discussed further in the “observations and conclusion” section of this commentary below. 5 The factual analysis of taking advantage In analysing the alleged taking advantage of market power by Cement Australia, three separate episodes of decision-making and conduct by Cement Australia were scrutinised:   10 11 12 Second, entering into an amended version of that contract with the Millmerran power station at the specified price (“maintaining the Millmerran contract”).  9 First, execution of a contract for the supply of flyash from the Millmerran power station to Cement Australia in the upstream market, at the specified price, bearing in mind the existence of an existing similar contract between Cement Australia and the Tarong power station (“entering into the Millmerran contract”). Third, the exercise of an election to proceed in relation to the Millmerran contract, resulting in the construction of processing capacity for flyash from Millmerran, notwithstanding that such processing capacity was costly to construct and may remain unused (building excess capacity). Ibid at [1899] and [1900]. Ibid at [1902]. Ibid at [1903]. Ibid at [1904]. APAC-#21911909-v1 3 © Norton Rose Fulbright Australia

Case note for Australian Journal of Competition & Consumer Law (AJCCL) – 1 March 2014 Each of these “episodes” involved steps taken by Cement Australia to secure exclusive supply of flyash from the Millmerran power station in circumstances where it already had access to sufficient flyash from other power stations to meet downstream demand. Moreover, the ACCC alleged that the price paid by Cement Australia for the flyash made “no commercial sense” for anyone without substantial market power in the same position, as the price paid could not be recouped. In respect of each of these episodes, Cement Australia advanced multiple business reasons for the conduct. The business reasons generally sought to explain why Cement Australia contracted to acquire flyash from the Millmerran power station in the upstream market in excess of demand in the downstream market. A large part of His Honour’s lengthy judgement involves an analysis of these business reasons and their evidential credibility. A consolidated summary of some of these reasons is set out below:  By securing more than one source of supply, Cement Australia was better protected against the risk of a shutdown of a power station (or other unpredictable events or interruptions) in order to preserve continuity of supply.  Growth in the downstream market was anticipated over the long term thereby potentially necessitating acquisition of flyash from the Millmerran power station.  Cement Australia originally bid for the Millmerran and Tarong contracts simultaneously in order to win one and did not know whether it would win both. Cement Australia was then simply maintaining pre-existing contracts and arrangements.  The quality of flyash from the Millmerran power station was inferior to Tarong, hence Cement Australia was seeking to manage its risk around the quality of flyash.  Access to two sources of flyash meant that Cement Australia could create a supply buffer and manage short run supply shocks. Of the various reasons advanced, the reasons accepted by His Honour for the three “episodes” under consideration are set out in the following table: Episode Reasons accepted by Justice Greenwood Entering into the Millmerran contract Justice Greenwood considered that Cement Australia originally bid for the Millmerran and Tarong contracts simultaneously at the specified prices as Cement Australia had some uncertainty whether it would win either of them. His Honour then required evidence that the Millmerran contract was independently profitable at the contracted price. His Honour asked the question (at para 2279) “whether a corporation in the position of [Cement Australia] without market power, and thus operating in a workably competitive market, could profitably enter into the Millmerran transaction on the terms and conditions of that transaction”. In this regard, His Honour identified (at paras 2293 to 2301) that the price bid by the rival bidder was near that of Cement Australia. Accordingly, if a firm without market power had bid at that level, the court could infer the price bid by Cement Australia did not involve a taking advantage. Maintaining the Millmerran contract APAC-#21911909-v1 Justice Greenwood accepted evidence that there were problems with the quality of flyash from the Millmerran power station. Indeed, the flyash was subsequently determined to be unusable for the supply into 4 © Norton Rose Fulbright Australia

Case note for Australian Journal of Competition & Consumer Law (AJCCL) – 1 March 2014 the downstream market. His Honour reasoned (at para 2687) that “…a corporation without market power in the position of Cement Australia.. confronted with a problem of product quality in an industrial process application that may have rendered the product practically and economically [unusable], may well (and could have) [maintained the Millmerran contract at the specified price] to extend the period of investigation to enable a final informed view to be reached about the quality of the ash...” His Honour also considered the price payable under the contract to determine if it was “hopelessly uneconomic” such that it was unprofitable for Cement Australia to maintain the Millmerran contract. His Honour accepted (at para 2693) that “…objectively viewed, over the economic life of the contract…such a contract was not so hopelessly uneconomic that a profit maximising corporation with no market power operating in a workably competitive market could not have elected to amend the contract to allow a reasonable period of time to [determine the marketability of the flyash].” Building excess capacity Justice Greenwood reasoned (at para 2976) that Cement Australia had a contractual obligation to construct the relevant processing capacity, hence there was no taking advantage of market power. While it would have been open to Cement Australia to seek to amend the Millmerran contract to avoid this cost, His Honour reasoned that it was not appropriate for the court to second-guess the commercial options available and prefer one option over another. 6 Cement Australia had the requisite purpose Given Justice Greenwood’s conclusion that Cement Australia was not taking advantage of its market power, His Honour was not required to express a view on Cement Australia’s purpose, the third limb of section 46 of the Act. However, His Honour’s conclusions in relation to section 45 suggest he would have found that an anti-competitive purpose existed in relation to section 46. In relation to section 45, His Honour was required to consider whether Cement Australia entered into or gave effect to any contractual provisions that had the purpose of substantially lessening competition in a market. Based upon the evidence presented in the case, including internal communications, witness testimony and board papers, Justice Greenwood was able to infer an anticompetitive purpose sufficient to meet the requirements of section 45. His Honour reasoned that the steps taken by Cement Australia to secure supply of flyash at the relevant power stations were for the substantial purpose of foreclosing entry into the downstream market by preventing a rival (particularly Boral) from securing access to sufficient flyash. More specifically, the particular provisions in the relevant contract had that purpose.13 His Honour separately identified that such foreclose had the effect of substantially lessening competition, commenting that he was “satisfied that the future process of competition in terms of the future field of rivalry would have been more vigorous, more dynamic and more contestable without the identified provisions as compared with the future face of rivalry with the provisions in place”.14 13 14 Ibid at Part 50. Ibid at [3241]. APAC-#21911909-v1 5 © Norton Rose Fulbright Australia

Case note for Australian Journal of Competition & Consumer Law (AJCCL) – 1 March 2014 As a result, His Honour found that by entering into and giving effect to the relevant provisions in the relevant contracts with the purpose of substantially lessening competition, Cement Australia had contravened section 45 of the Act. 7 Intervening factors prevented an anti-competitive effect Interestingly, his Honour concluded that notwithstanding that Cement Australia had an anticompetitive purpose, the relevant contractual provisions did not have the effect or likely effect of substantially lessening competition. His Honour reasoned that while Cement Australia acted with the purpose of substantially lessening competition by foreclosing access by competitors to flyash, Cement Australia did not achieve that purpose in practice because other circumstances would have denied access by those competitors to the relevant flyash. In particular, His Honour reasoned the poor quality of the flyash produced by the Millmerran power station rendered it unusable by Cement Australia. His Honour reasoned that “any effect or likely effect upon competition was then attributable to the compromised quality of the Millemerran flyash rather than the effect or likely effect of the identified provision”.15 8 Observations and conclusions The Cement Australia decision was directed at conduct in which a predatory buying strategy was used to corner a market and foreclose competition. While this type of conduct is normally considered under the unilateral conduct provisions in section 46 of the Act, the involvement of contracts enabled the ACCC to take action under section 45. While the ACCC was able to establish a contravention under section 45 relatively easily based on the existence of an anti-competitive purpose, it struggled to establish a contravention under section 46 notwithstanding the existence of that purpose. The ‘could’ test for ‘taking advantage’ under section 46 that Justice Greenwood was required to apply enables a firm with substantial market power to escape liability if it can establish that only one of the legitimate business justifications it advances is profitable. However, Justice Greenwood was required to make his decision under a formulation of section 46 that preceded the enactment of the new ‘taking advantage’ factors into section 46(6A). The new factors expressly give a court a discretion to apply a broader “would” test. It therefore remains open to speculation whether His Honour’s decision may have differed if the case had been decided under the current formulation of section 46. His Honour did make some relevant observations that may assist the application of the ‘taking advantage’ factors in section 46(6A) by future courts:   15 16 17 His Honour observed that taking advantage of market power does not encompass conduct which has the purpose of protecting market power, but no other connection to the market power. There must be a method of using the market power that is made possible only by the absence of competitive conditions.16 This observation narrows the interpretation of the words “otherwise related to” in section 46(6A)(d) of the Act. His Honour observed that while a contravention must be established on the balance of probabilities, a court should assess whether the alleged anti-competitive conduct is “very unlikely or highly unlikely” in a workably competitive market. In doing so, a court should have regard to the costs incurred as a profit maximising firm, relative to the benefits that the firm would derive from engaging in the conduct.17 Ibid at [5]. Ibid at [1908]. Ibid at [1911] and [1912]. APAC-#21911909-v1 6 © Norton Rose Fulbright Australia

Case note for Australian Journal of Competition & Consumer Law (AJCCL) – 1 March 2014 As at 27 February 2014, the Federal Court of Australia has not yet made orders as to penalties. Once such orders are made, an appeal to the Full Federal Court could occur. As at 27 February 2014, neither the ACCC nor Cement Australia have made any public comments whether or not they intend to appeal. Authors personal details Dr Martyn Taylor, Partner Norton Rose Fulbright Tel +61 2 9330 8056 martyn.taylor@nortonrosefulbright.com Claire Forster, Senior Associate Norton Rose Fulbright Tel +61 2 9330 8168 claire.forster@nortonrosefulbright.com APAC-#21911909-v1 7 © Norton Rose Fulbright Australia

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