Supreme Court dismisses Commerce Commission's section 36 appeal
The Supreme Court yesterday finally rejected the Commerce Commission's decade-old claim that Telecom's 0867 internet package breached section 36 of the Commerce Act 1986. Confirming the central importance of the counterfactual test under section 36, the unanimous judgment stresses that a dominant firm should not fear to act competitively. The Supreme Court also emphasised that it is important that the test for use of market power give firms and their advisers a reasonable basis for predicting in advance whether their proposed conduct might risk breaching section 36.
Background
As part of the government's privatisation of telecommunications in the early 1990s, Telecom became the owner of the nationwide copper-based telephone network ("PSTN"). Clear connected its network to the PSTN under an interconnection agreement with Telecom. When a Telecom customer called a Clear customer, Telecom paid per-minute "termination charges" to Clear under their interconnection agreement and vice versa.
When Clear first emerged, it paid the majority of termination charges to Telecom since its customers made more calls to Telecom customers than the other way round. With the advent of dial-up internet in the late 1990s, Telecom's residential customers began making numerous lengthy calls to internet service providers ("ISPs") connected to Clear's network. Those calls commonly lasted longer than voice calls, so Telecom suddenly found itself both in possession of a heavily congested network and paying sizeable termination charges to Clear. It responded by introducing the 0867 package, which encouraged residential customers and ISPs to migrate to Telecom and Clear to adopt the 0867 prefix for internet calls on its network (no termination charges were payable for such calls).
The Commission alleged that this amounted to a breach of section 36. The claim was brought under the old wording of section 36 (use of a dominant position), which was subsequently amended in 2001 (taking advantage of a substantial degree of market power). The High Court, the Court of Appeal and the Supreme Court all rejected the Commission's contentions. The Supreme Court's judgment had little to say on market definition, market power or purpose. It focussed instead on a single, troublesome aspect of section 36 - how to determine whether a defendant has "used" its dominant position in a market.
Use of dominance
At the outset, the Supreme Court observed that the old "use" wording involves the same inquiry as the new "take advantage of" wording. That means that its observations in the 0867 judgment are of more than simply historical interest - they represent the law under section 36 as it currently stands.
The real question in the appeal was whether section 36 requires what has come to be known as a 'counterfactual test'. The Supreme Court concluded that it does. To use their carefully chosen words:1
The essential point is that if the dominant firm would, as a matter of commercial judgment, have acted in the same way in a hypothetically competitive market, it cannot logically be said that its dominance has given it the advantage that is implied in the concepts of using or taking advantage of dominance or a substantial degree of market power. Conversely, if the dominant firm would not have acted in the same way in a hypothetically competitive market, it can logically be said that its dominance did give it the necessary advantage. This is because it can then reasonably be concluded that it was its dominance or substantial degree of market power that caused, enabled or facilitated its acting as it did in the actual market.
The comparative exercise is designed to pose and answer the question whether the presence of competition in the hypothetical market would have restrained the alleged contravener from acting in that market in the same way as it acted in the actual market. If the answer is yes, the alleged contravener has taken advantage of its market power. If the answer is no, it has not done so, because the presence of that power gave it no material advantage.
The Supreme Court's approach involves comparing the defendant's actual conduct with how it would have acted in a hypothetical competitive market (the counterfactual). The Supreme Court provides some useful observations on constructing this hypothetical. It will be identical to the real world, save that the dominance of the defendant is eliminated by stripping out or neutralising the features which gave rise to dominance in the actual market. The hypothetical market need not be perfectly competitive, just sufficiently competitive that no one competitor is dominant (ie "workably" competitive). It was also observed that in the hypothetical market there will be at least one other non-dominant firm.
Telecom's dominance was assumed to arise here from its ownership of the PSTN (usually thought to be a natural monopoly). The Supreme Court's counterfactual involved simply imagining a world in which Telecom's PSTN competed with at least one other PSTN. Other aspects of the real world (such as Telecom's Kiwi Share Obligation and its interconnection agreements with competitors) remained in place.
It is then necessary to go on to determine what the defendant would (rather than could) have done in that alternative world. Ultimately, that is a commercial judgment to be made objectively and based on all of the factors that would have influenced rational business people. Although the Supreme Court felt that economic analysis could help to construct the hypothetical market, the question of what the defendant would have actually done in that counterfactual is ultimately one of "rational commercial judgment". As such, the Supreme Court held that anyone asserting a breach of section 36 must show, on the balance of probabilities, that the firm would not have acted as it did in a workably competitive market.
The Supreme Court concluded here that in a hypothetically competitive market Telecom would still have introduced the 0867 regime to resolve the network congestion and termination charge imbalance. The Commission claimed in argument that a competitive Telecom would not have done so because it would have risked losing customers to other networks, but it had failed to adduce the evidence it needed to back up that claim. The Supreme Court roundly criticised the Commission for attempting to remake its case at appellate level on that "speculative" basis.
Implications
There are four main points to take away from the judgment.
First, it is now beyond doubt that the way to determine whether a firm has taken advantage of its market power is to ask whether it would have acted differently in the counterfactual. Anyone asserting a breach of section 36 must show, on the balance of probabilities, that the firm would not have acted as it did in a workably competitive market.
Secondly, the counterfactual will be identical to the real world, save that the defendant will be stripped of the features that give rise to its market power. While the hypothetical market need not be perfectly competitive, it will include at least one other firm in effective competition with the defendant.
Thirdly, a plaintiff will need to provide the court with good evidence as to what the firm would or would not have done in the counterfactual. Economic evidence may help to define the counterfactual, but it is ultimately up to the court to determine how the firm would have acted in that counterfactual.
Finally, the Supreme Court reviewed the relevant case law in Australia and determined that the "counterfactual" approach was consistent with the approach taken to market power cases in Australia.
Contributed by Andy Glenie, Haidee Leung, Chris Bowden and Andrew Peterson