Tying up the market - when your contracts cumulate into anti-competitive conduct

Articles Written by Sar Katdare (Partner)

The long-awaited decision of the Federal Court in ACCC v Cement Australia demonstrates that if you seek to "tie up" the market through contractual arrangements with your suppliers (or customers), you will run the risk of contravening competition laws.

In particular:

  • if you have a substantial degree of power in a market, you should be careful when entering new contracts or extending the term of existing contracts if such conduct is likely to prevent your rivals from entering or competing in a market;
  • you should consider the aggregate competitive effects of your contractual arrangements and not view them in isolation; and
  • while contracts entered into as a result of bidding for and winning a competitive tender may minimise competition concerns in certain circumstances, if a substantial purpose for your bid is anti-competitive (e.g. to exclude rivals) this could still raise issues, even if you also have legitimate commercial motives.

In this case, Cement Australia was found to have not misused its market power, on the basis that it did not "take advantage" of that power. However, the Court held that Cement Australia contravened the prohibitions against making and giving effect to arrangements that have the purpose or effect of substantially lessening competition in a market.

The facts in Cement Australia

Cement Australia purchased "flyash" in South East Queensland (SEQ) between 2001 and 2006.

Flyash is a by-product of the combustion of black coal in electricity-generating power stations. Flyash produced by power stations is unprocessed but when processed into a fine powder, flyash is used to make concrete.

At the relevant time, there were four power stations in SEQ that were capable of producing flyash: Swanbank (S) - which provided small amounts of flyash; Tarong (T1) - the main source of flyash in SEQ; Millmerran (M) - a new source of flyash; and Tarong North (T2) - adjacent to T1.

Cement Australia had existing contracts with Sand T1 that allowed it to effectively acquire all flyash produced from those power stations. M and T2 were not producing flyash for purchase at the time. As a result, Cement Australia was the only acquirer of unprocessed flyash in SEQ and the only supplier of processed flyash for concrete making in SEQ.

From 2002 to 2006, Cement Australiaengaged in the following conduct:

  • as a result of bidding for and winning a competitive tender process for the acquisition of flyash from M, Cement Australia entered a contract in September 2002 to acquire all of the flyash from M for 7 years;
  • given the imminent expiry of its T1 contract, Cement Australia bid for and won a competitive tender process in February 2003 and entered a new T1 contract to acquire all of the flyash from T1 and T2 for 5 years;
  • Cement Australia then extended the S contract until December 2004 and again 4 separate times to December 2006;
  • in July 2004, although it had not acquired any flyash from M due to quality issues, Cement Australia elected not to terminate the M contract but instead extended the term of the contract;
  • in April 2005, although it had still not acquired any flyash from M, Cement Australia again elected not to terminate the M contract (or renegotiate it to reduce payments) but extended the term of the contract and approved investment in new processing facilities;
  • Cement Australia maintained the M contract despite the fact that the flyash it acquired from Sand T1 exceeded actual and forecast demand in the market; and
  • in 2006, Cement Australia constructed facilities at T2 which enabled it to acquire flyash from T2 and deposit any reject flyash into a "communal" silo. Up until that point, third parties could obtain commercially acceptable flyash from T2 via the "communal" silo. After Cement Australia constructed its facilities and transported reject flyash to the silo, there was significant third party uncertainty as to whether the flyash was of commercial standard to use in concrete making.

A misuse of market power or anti-competitive agreements?

The ACCC claimed that by entering and extending the various acquisition contracts in circumstances where there was no commercial rationale to do so, Cement Australia misused its market power in the downstream market for the supply of processed flyash in SEQ. For its claim to succeed, the ACCC needed to show that

  1. Cement Australia had substantial market power;
  2. Cement Australia took advantage of that power; and
  3. it did so to prevent entry or competition in that market or the upstream market for the acquisition of unprocessed flyash.

The ACCC also claimed that Cement Australia entered into and gave effect to arrangements that had the purpose and effect of substantially lessening competition in those markets.

What was Cement Australia's defence?

Cement Australia argued that:

  • it did not have substantial market power because the M and T1 contracts were the subject of a competitive tender process - if they did not win a tender, a rival would win which meant that in the long term, any market power was transitory;
  • it did not take advantage of any market power because a rational, profit maximising firm without market power could engage in the same conduct (and in fact rivals without market power did bid for the contracts); and
  • its purposes in entering and extending contracts were: to have a secure and consistent supply of flyash from diverse sources in order to maintain its market position by overcoming operational issues (shortages, breakdowns, etc); to develop new sales opportunities in the long term; and to discharge its contractual obligations.

The decision - no misuse of market power but agreements found to be anti-competitive

Misuse of market power

Greenwood J found that Cement Australia had substantial market power in the market for supply of processed flyash in SEQ because it effectively had exclusive rights to acquire all available flyash from the two power stations (S and T1) producing flyash at the time. It was almost impossible for a rival to enter the market given Cement Australia's existing contracts and other high barriers to entry. In making this finding, the Court relied upon Cement Australia's internal documents which expressed a view that the company itself considered it was a dominant or sole supplier of processed flyash in SEQ.

His Honour noted that even though there was uncertainty as to whether Cement Australia would win the competitive tenders (and whether contracts would stay on foot), a firm does not "lose" market power it otherwise enjoys simply because this uncertainty may exist. This would only be the case if the potential threat of rival entry is real and imminent such that the relevant firm is not free to act without constraint.

As to the issue of whether Cement Australia took advantage of its market power, the Court held that the relevant test was whether Cement Australia could have profitably entered and extended the contracts in a workably competitive market (i.e. one in which it did not have market power). If so, there was no "taking advantage" of market power.

Greenwood J found that it would be rational for a firm without market power to bid for the M contract in circumstances where it was uncertain whether the existing S and T1 contracts would continue and subsequently for the T1 contract in circumstances where the quality of flyash from the new M was unknown and uncertain. The court relied upon the fact that Transpacific, a competitor of Cement Australia with no market power, no incumbent relationships or contracts and no storage or distribution facilities, strongly competed for contracts in the tender process.

The court also found that extending the M contract in circumstances where Cement Australiahad not acquired flyash from M and flyash from S and T1 exceed actual and forecast demand was not conduct referable to market power - it was the simple performance or discharge of contractual obligations, not a taking advantage of market power.

On the issue of "purpose", Greenwood J accepted that Cement Australia had legitimate business reasons for entering and extending contracts including ensuring certainty and diversity of supply and discharging its contractual obligations. However, through oral testimony and documentary evidence, His Honour held that there was another substantial purpose for entering the contracts - namely, to prevent entry or competition from a rival in the relevant markets.

In summary, while Cement Australia had substantial market power and a proscribed anti-competitive purpose, it did not "take advantage" of that power.

Anti-competitive agreements

In light of its findings on purpose above, the Court found that Cement Australia made and gave effect to arrangements that had the purpose of substantially lessening competition in the relevant market.

The Court also found that the S and T1 contracts had the effect of substantially lessening competition in the relevant markets because they "prevented" the outbreak of competition which would otherwise have occurred if a rival acquired flyash from either of those power stations (and competed with Cement Australia in the supply of processed flyash in SEQ).

As the quality of flyash from M turned out to be poor, the M contract was found not to have the effect of substantially lessening competition in the relevant markets because even if a rival won the M tender, it would not have been able to profitably sell flyash in competition with Cement Australia.

Would the result be different with the application of new laws?

Cement Australia was decided prior to the enactment of section 46(6A) of the Competition and Consumer Act. That section allows the court, in assessing whether a firm has taken advantage of its market power, to have regard to whether the relevant conduct was materially facilitated by, relied on or was otherwise related to the firm's market power.

The section appears to provide considerably more scope for a court to make a finding that a firm took advantage of its market. Prior to the section (as was the case in Cement Australia), the test was whether the relevant conduct could be engaged in only by virtue of (or otherwise was materially facilitated by) the firm's market power.

Would Greenwood J's finding that Cement Australia did not take advantage of its market power be reversed if section 46(6A) was in play? Although the section appears to make it easier for a court to find the relevant connection between conduct and market power, there is little evidence to suggest that entry and extension of the contracts was materially facilitated by, relied on or was otherwise related to Cement Australia's market power.

Root and Branch Review of Section 46 

The ACCC's failure on the section 46 claim may provide added incentive for a recommendation to change the misuse of market power provisions under the impending Root and Branch Review of Competition Laws. While the review panel is tasked with "considering whether the misuse of market power provisions effectively prohibit anti-competitive conduct and are sufficient to: address the breadth of matters expected of them; capture all behaviours of concern; and support the growth of efficient businesses regardless of their size", there have been strong suggestions that the current provisions do not adequately protect small businesses from the conduct of big businesses. We will keep you updated as the review progresses.

Some practical lessons …

If you have a strong market position, you should monitor the aggregate competitive consequences of your contractual arrangements (in particular exclusive arrangements) on a rolling basis.

Ensure your papers are in order. Your internal documents are a great source of evidence - especially in determining whether you have substantial market power or anti-competitive purposes. 

Ensure your legitimate business purpose is the only one - having a legitimate purpose will be irrelevant if you also have an anti-competitive one. 

Important Disclaimer: The material contained in this article is comment of a general nature only and is not and nor is it intended to be advice on any specific professional matter. In that the effectiveness or accuracy of any professional advice depends upon the particular circumstances of each case, neither the firm nor any individual author accepts any responsibility whatsoever for any acts or omissions resulting from reliance upon the content of any articles. Before acting on the basis of any material contained in this publication, we recommend that you consult your professional adviser. Liability limited by a scheme approved under Professional Standards Legislation (Australia-wide except in Tasmania).

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