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Considering selling your business? Consider this. Usually the Commerce Act implications of a merger or acquisition are the responsibility of the prospective buyer, but in a recent High Court decision a vendor was found to have fallen foul of the legislation. Simpson Grierson's competition group comments on the decision and implications for vendors.
Business Acquisitions under the Commerce Act
Section 47 of the Commerce Act prohibits the acquisition of assets or shares of a business if the acquisition would have or would be likely to have, the effect of substantially lessening competition in a market. This means that for some acquisitions the implications of the purchase need to be carefully considered before settlement. An acquisition which does have the effect of substantially lessening competition in a market will be in breach of the Act and may result in the Commerce Commission seeking an award of penalties against the contravener of up to $5 million dollars for a body corporate and $500,000 for an individual.
To avoid breaching section 47, a person proposing to acquire the assets or shares of a business may seek a clearance from the Commerce Commission. The Commission under its statutory powers will grant a clearance providing that it is satisfied that the purchase will not have the effect of substantially lessening competition in a market. Where an application is declined, a purchaser who enters into an agreement for the purchase of the assets risks prosecution for breach of section 47.
Typically it has been the purchaser of the assets or shares that has been thought to be at risk of prosecution by the Commission for breaching section 47. This is because section 47 specifically restrains the acquisition of assets or shares. However in a recent decision (on appeal) the High Court ruled for the first time that a vendor can be a party to a breach of section 47 .
The Vendor at Risk - Commerce Commission v NZ Bus
The decision of Commerce Commission v NZ Bus, concerned the acquisition of one Wellington bus company, Mana Bus (Mana), by a second bus company, NZ Bus, which was owned by Infratil Limited. NZ Bus, which was the largest bus company operating in the Wellington region, held a 26% shareholding in Mana, the second largest bus service operator in the region. The remaining 74% of Mana was controlled by one family, the Waddells, and their associated companies. Some of the family members acted as managers and directors of Mana while others were only shareholders in the company.
The two bus companies had a longstanding tacit understanding that they would not compete for business with one exception: they competed for contracts to supply school bus services.
Agreement for Sale and Purchase
In July 2005 the Waddells agreed to sell their 74% shareholding in Mana to NZ Bus. Subsequently, in December 2005, the Waddells executed an agreement to sell Mana to NZ Bus. This agreement was conditional on NZ Bus obtaining a clearance or authorisation from the Commerce Commission. Under the agreement NZ Bus was to apply for the clearance and was also to keep the vendors fully informed of the progress and details of the application. NZ Bus paid the Waddells a $3 million nonrefundable deposit.
Application for Clearance
NZ Bus applied for a clearance in January 2006 as agreed, the application being made on the grounds that the sale would not reduce competition in the region (given that the entities did not compete in any event). However the Commission indicated in a letter to NZ Bus in early March 2006 that its preliminary view was that there would be more competition in the region if Mana were purchased by a company other than NZ Bus.
On receipt of this letter, representatives of NZ Bus arranged to meet with the Commission to discuss the clearance application. The Court held that it was common ground between the parties that as a result of that meeting the representatives of NZ Bus knew that the Commission might decline clearance. The representatives of NZ Bus also believed the Commission had implied that withdrawal of the application should be considered.
Withdrawal of the Clearance Application
Following the meeting, the representatives of NZ Bus reviewed their position and agreed that their preference was to withdraw the clearance application and complete the acquisition of Mana. This action would avoid loss of the $3 million deposit. There would be time to divest Mana should the Commission commence litigation to restrain settlement. NZ Bus also took the view that the Commission was overworked and had more pressing issues to deal with.
NZ Bus then sought Mana's consent to waive the condition that clearance be required. At a meeting held with the managing director of Mana, Ms Waddell, NZ Bus’ representatives offered the Waddells an indemnity against any legal costs or fines should litigation be commenced by the Commission. Ms Waddell agreed to the waiver and indemnity conditional on the approval of the other shareholders and a letter between the parties recorded that the Waddells agreed to the waiver and indemnity on the basis of the information supplied by NZ Bus and its solicitors. The clearance application was then withdrawn and the agreement for the sale of Mana became unconditional.
Commencement of Proceedings
Following withdrawal of the clearance application, the Commission concluded that the sale would be likely to have the effect of substantially lessening competition and commenced proceedings to prevent settlement. The proceedings were however brought against both NZ Bus as the purchaser and the Waddells and their associated companies as vendors. In relation to the Waddells, the Commission claimed that by agreeing to waive the condition requiring clearance, the Waddells had abetted or conspired with NZ Bus to contravene section 47, or were directly or indirectly knowingly concerned in, or party to, the contravention by NZ Bus under section 83 of the Commerce Act.
The Commission also alleged that the parent company of NZ Bus, Infratil Limited, was a party to the breach of section 47 on the basis that Infratil was also concerned in and assisted in the acquisition of Mana.
Whether there was a Breach of the Act
Ultimately, and after a detailed analysis, the Court held that the sale did result in a substantial lessening of competition in "the market for rights to operate subsidised regular and/or school bus passenger services in the greater Wellington region, excluding the Wairarapa". NZ Bus was held to have breached 47 by acquiring Mana.
Parties to a Breach of the Act
The Court noted that the Commission had not previously targeted vendors as a party to a breach of the Act but considered that section 83 (the accessory liability section of the Commerce Act) could apply to vendors. This was because section 83(1)(e) applied to a person who simply participated in a transaction, and by definition, a vendor was a participant. The Court found however that vendors would only be liable as a party where they participated in the transaction knowing at the time the "essential facts" which establish a contravention of section 47.
Actual knowledge of these facts was required, although an accessory would not need to appreciate that the facts known to them would in fact establish a breach of the Commerce Act.
The Court found that the essential facts included knowledge of the competitive environment in which the proposed acquisition was taking place as well as the circumstances and implications of the transaction. Relevant factors were:
The likely market position of the merged firm;
What was likely to happen to the assets or shares if the transaction did not proceed; and
Whether a significant competitive advantage was likely to result from the transaction.
The Court noted that the list of essential facts "comprises things that any substantial and longstanding market participant is likely to know, at least in general layman's terms, because success in business depends on them".
Liability of Managers and Directors of Mana
The Court held that the managers and directors of Mana were aware of the essential facts concerning the transaction and therefore were parties to the transaction under section 83. The managers had had a long-standing involvement in the management of Mana with the result that they were aware of all the relevant essential facts leading to a breach of section 47.
Liability of the Shareholders in Mana
The remaining shareholders however, being other Waddell family members and the family's associated interests, were not parties to the breach. The Court noted that although Ms Waddell had clearly acted as an agent of the other shareholders as far as the waiver was concerned, that was not enough to establish a general agency relationship. Directors and company executives are not ordinarily agents of shareholders and there was no other evidence which justified an inference of agency.
Liability of Infratil Limited
Similarly, the Court held by a narrow margin that Infratil, NZ Bus’ parent company, was not a party to the breach of section 47. The Court noted that there was no doubt that Infratil had been concerned in, and assisted NZ Bus in the decision to waive the condition for clearance. However the Court also found that as Infratil had only purchased NZ Bus in November 2005 it could not be expected to have knowledge of some aspects of the market or the fact that there was a tacit understanding between the companies not to compete. In these particular circumstances, Infratil's knowledge of the essential facts was inadequate, justifying the decision that Infratil was not a party.
With respect to the legal advice which Infratil had received which indicated that the acquisition probably complied with section 47, the Court noted that such advice did not in any event supply a defence to the claim.
Penalty Decision – Factors to be taken into Account
In considering the appropriate penalties, the Court remarked on two factors in particular which had implications for the penalty to be applied. First the Court considered that legal advice indicating that the acquisition complied with section 47 is not a mitigating factor, as such advice may only show that the acquirer reached their decision to acquire on reasonable grounds. As such the Court considered that for the purposes of determining the penalty, favourable legal advice was better characterised as the absence of an aggravating factor.
Second, the Court considered that there was a reason to increase the penalty where the acquirer took a calculated risk that the Commission lacked the resources to enforce the law or gambled that the acquisition would remain undetected. As section 83 was concerned with deterrence, there was a correlation between resources devoted to enforcement and penalty. In short, where the enforcement resources were smaller and there was more chance of escaping sanctions, the greater the penalty required.
Penalties and Costs
The Court concluded that the breach of section 47 was akin to an attempt, as the transaction never settled due to the Commission's intervention and NZ Bus was fined $500,000. Although the starting position for the Court was $2 million, being NZ Bus' potential unlawful gain from the transaction, this was discounted for the Commission's contribution to the breach, the absence of loss, and the stigma associated with the Court's findings. As for the executives of Mana, the Court considered them less culpable given their reliance on information from NZ Bus' advisors and no penalty was imposed.
The final matter was however the costs and disbursements claimed by the Commission, which were approximately $650,000. These were awarded as claimed against NZ Bus and the executives of Mana, the Court dismissing an argument that the established practice for costs awards was that losing parties would only be required to pay 75% of the costs claimed. The saving grace for the executives of Mana however was the indemnity against legal fines and costs provided by NZ Bus at the time the waiver was given. This indemnity was accepted as lawful by the Commission with the result that NZ Bus was solely liable for the full amount of costs claimed.
Vendor Beware!
Despite the action failing against the majority of the shareholders, it is apparent from the decision that vendors are likely to be at risk of being found liable as a party where an acquisition results in a substantial lessening of competition. As recognised by the Court, it will be a rare case in which the vendor's participation in the transaction is not deliberate. Vendor executives are likely to have actual knowledge of the circumstances of the sale, as well as the competitive environment and the impact that the transaction may have on the market.
So what can Vendors do to Protect their Position?
It is clear from this decision that vendors need to carefully consider how they deal with the sale of their business where the acquisition is likely to raise Commerce Act issues. Vendors may need to make strategic decisions at an early stage in the transaction about whether they wish to remain at arms length from the issues, or whether they should get involved in the process and insist that the purchaser apply for clearance.
The decision also highlights that vendors need to be very careful if they find themselves in the situation where a clearance application is filed and then withdrawn, or where there is any indication from the Commerce Commission that the application may be declined.
Finally, as a practical protection, vendors should consider requesting an indemnity from the acquirer in the event that the Commission litigates. Such an indemnity will not protect a vendor from liability as a party, but it seems that it will protect a vendor's pocket.
Purchasers Beware!
Although this decision is unique because of its focus on the liability of vendors, the case also illustrates that the Commission is not averse to taking swift legal action against acquirers if it thinks that a transaction will result, or does result in a breach of section 47. Furthermore, the case indicates that the potential penalties and costs for breach may be substantial (in this case, over $1.1 million combined, excluding legal costs) even where the transaction does not settle.
Decision on Appeal
The High Court decision has been appealed by NZ Bus and is set down for hearing in the Court of Appeal on 18 September 2007.
This newsletter is produced by Simpson Grierson. It is intended to provide general information in summary form. The contents do not constitute legal advice and should not be relied on as such. Specialist legal advice should be sought in particular matters.
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