Start-Up Speculation: Evaluating Recommendation 2.3 of “Examining the Canadian Competition Act in the Digital Era”
Davis Haugen, 3L, Volume 81 Senior Editor
New recommendations from Canada’s Competition Bureau could dramatically alter the country’s competition law landscape. In its February 2022 publication Examining the Canadian Competition Act in the Digital Era (Bureau Submission), the Competition Bureau proposed a variety of reforms to the Competition Act, 1985. Recommendation 2.3 aims to lower the evidentiary burden placed on the Commissioner when attempting to block a dominant firm from acquiring an emerging competitor—at least in the case of digital markets. The proposed recommendation responds to a trend of nascent or “killer” acquisitions in the technology space, where dominant firms acquire start-ups for the purpose of “pre-empting the emergence of future competition” (OECD (2020), “Start-ups, Killer Acquisitions and Merger Control”).
While the current legal test for analyzing the anti-competitive effects of a merger contains bright-line requirements, the Bureau’s submission suggests a more “flexible” standard (Bureau Submission, s. 2.3). Replacing a bright-line rule with a more flexible one, while ensuring fewer anti-competitive nascent acquisitions proceed, may also translate into greater legal and commercial uncertainty for merging parties. This increased uncertainty can in turn substantially impact innovation and incentives for entrepreneurs. This leaves an open question as to whether other sections of the Competition Act, such as s. 79 (abuse of dominance), might more appropriately address the issue of dominant firms acquiring start-ups to pre-empt competition than merger review under s. 92 of the Act.
Background
On Oct. 27, 2021, Senator Howard Wetston published a consultation invitation to assess whether Canada’s existing competition law framework remains appropriate in a digital era. In response to the call for submissions, the Competition Bureau submitted “Examining the Canadian Competition Act in the Digital Era” on Feb. 8, 2022. Around the same time, the Minister of Innovation, Science and Industry also announced that the federal government intended to conduct a comprehensive review of the Competition Act. The Bureau’s submission serves as an important development in recent policy discussions surrounding the Act.
Section 92 of the Competition Act governs the analysis of mergers. Under s. 92(1), the Competition Tribunal can reject a proposed merger if it “prevents or lessens, or is likely to prevent or lessen, competition substantially” (emphasis added). Two key cases set out the requirements for how the Competition Tribunal identifies whether a merger will “substantially” prevent competition. In Tervita Corp v Canada (Commissioner of Competition), 2015 SCC 3 (CanLII) (Tervita SCC), the Supreme Court of Canada (SCC) stated that the Commissioner must “assess the competitive landscape that would likely exist if there was no merger” by identifying the potential future competitor, assessing whether that competitor would likely enter the market, and determining whether its effect on the market would likely be substantial (para 60). In 2019, The Commissioner of Competition v Vancouver Airport Authority, 2019 Comp Trib 6 (Vancouver Airport Authority) added that the Commissioner must provide clear and convincing evidence of “concrete market opportunities” that would likely have been, or likely would be, available to a new entrant, so that the entrant would “be likely to have a material effect on competition in the relevant market” (paras 666-67).
The Bureau’s submission to Senator Wetston stresses that requirements placed on the Commissioner under the Vancouver Airport Authority standard are too burdensome. Instead, the Bureau proposes a more flexible requirement in Recommendation 2.3:
The standards established from analysis of more traditional industries are not suitable for
assessing acquisitions of emerging competitors in the digital economy. A more workable
standard would provide additional flexibility to protect the competitive process.
(emphasis added)
The Bureau’s comments are very general at this stage, making it is unclear exactly how the new, more flexible standard, will be articulated. We may be able to draw some inferences from the Australian, UK, and US standards cited by the Bureau in Recommendation 2.3. In those countries, nascent acquisition review is conducted on the basis of whether there is a “non-remote possibility” that an emerging competitor could become an effective competitor, or where there is a “realistic prospect” that competition would be lessened (Bureau Submission, s. 2.3). Although Recommendation 2.3 does not offer a precise vision of the new framework, the recommendation clearly indicates the Bureau’s desire to move away from a bright-line rule in favour of a more “flexible,” open-ended standard.
Uncertainty in Evaluating Nascent Acquisitions
Evaluating the future competitive effects of a merger means “look[ing] into the future,” making it a “necessarily forward-looking” analysis (Tervita SCC at paras 52-53). While this inevitably entails some degree of uncertainty in evaluating an acquisition’s potential anti-competitive effects, that uncertainty is compounded when the target is a start-up.
When an incumbent firm acquires a nascent firm, the two firms are generally not competitors at the time of the acquisition. Rather, the incumbent’s concern is that, absent a merger, the two firms may become competitors in the future. Competition authorities are tasked with determining whether this concern is well-founded—that is, whether it is likely that the start-up firm would indeed compete with the acquirer in the future if it were not acquired. Since it is highly uncertain whether a small start-up with an unfinished product will someday be a competitive threat to a dominant firm, determinations about the future competitive position of a start-up are inherently speculative.
First, an emerging firm may not have finalized technology or products. This makes it hard for competition authorities to know what product markets the firm will operate in and whether the firm is likely to successfully scale its business. The nascent nature of a start-up therefore creates uncertainty surrounding how quickly, and in what ways, the company will grow over time.
Second, the types of industries that start-up firms operate in generate additional uncertainty for competition authorities conducting merger review. In a 2020 paper titled “Nascent Acquisitions,” Hemphill and Wu note that nascent competition is most important in industries “marked by rapid innovation and technological change” (pg. 1887). These characteristics introduce more guesswork into merger analysis, as rapid innovation makes it harder to predict what a firm’s future competitive position in a market will be, or what product markets they may enter in the future. These industry characteristics make predicting the competitive effects of the merger more uncertain, and therefore make analyzing whether an acquisition would “substantially prevent competition”—an analysis which is already inherently forward-looking—even more speculative.
Why Increased Uncertainty Should be Addressed
The Bureau’s criticism of Vancouver Airport Authority and its desire for “additional flexibility” in Recommendation 2.3 may suggest that uncertainty will not be addressed under the newly proposed standard to the same extent as it was under the Vancouver Airport Authority standard. This is concerning because increased uncertainty poses several issues for a review process already characterized by a high degree of speculation.
One issue is that replacing strict, factual requirements with a standard which provides “additional flexibility” may make it harder for merging parties to predict the outcome of competition review and proceedings. If the legal standard does not require proof of specific facts (such as concrete market opportunities available to entrants), adjudicators will need to exercise greater judicial discretion when evaluating whether an acquisition will substantially affect future competition. This increased discretion, combined with a forward-looking legal test, can lead to a wide range of potential outcomes in competition proceedings and, as a result, less legal and commercial certainty for merging parties and the start-up target’s investors. Consequently, this uncertainty may have unintended effects on innovation by new firms.
For instance, in “Nascent Acquisitions,” Hemphill & Wu recognized that “acquisition can act as an important exit for investors in a small company, therefore attract[ing] capital necessary for innovation” (p. 1881). Increased uncertainty makes it harder to predict whether the acquisition of a start-up will be permitted under competition law, and consequently may undermine the willingness of investors to invest in start-ups. A decrease in start-up investment could in turn negatively affect the very innovative developments that these smaller firms often pioneer.
Additionally, many entrepreneurs develop start-up businesses with the express intention of having them be acquired by a larger firm in the future. This is especially true for what Wright, Robbie, and Ennew refer to as “Serial Entrepreneurs”. Serial entrepreneurs are people who found start-ups, sell them to larger competitors, and then go on to create additional start-up businesses.
Serial entrepreneurs can drive innovation, as they may develop multiple innovative products and disruptive new businesses throughout the course of their careers. Serial entrepreneurship also may increase the likelihood of innovative firms succeeding due to learning curve effects, as Sarasvathy, Menon, and Kuechle explain in their article, “Failing firms and successful entrepreneurs: serial entrepreneurship as a temporal portfolio.” Because of their repeated involvement in starting businesses, serial entrepreneurs are well-positioned to draw on this wealth of experience and produce progressively more successful ventures over time. However, too much uncertainty surrounding competition law’s treatment of nascent acquisitions may alter the feasibility of, and incentives associated with, serial entrepreneurship, potentially stifling innovation in the process.
Finally, Canadian competition jurisprudence has emphasized the importance of predictability and commercial certainty when analyzing mergers, such as in the Federal Court of Appeal’s decision in Tervita. While the Federal Court of Appeal’s decision was later reversed, the principles it articulated about commercial certainty in its s. 92 analysis are still relevant. The court recognized that objective standards are important in competition law to “discourage the use of arbitrary judgments and reduce overall uncertainty in the Canadian business community” (para 152). Therefore, we should be mindful of the effects on commercial certainty when implementing more flexible standards for nascent acquisition review.
Fortunately, the Competition Bureau’s submission seems alive to concerns about uncertainty—Recommendation 2.3 recognizes that it may be unclear whether an emerging firm will develop a competitive product in the future. Yet, the question remains as to whether and how this uncertainty will be addressed under the more flexible standards advocated for in Recommendation 2.3. How will the uncertainty inherent to nascent acquisitions be mitigated under the new standard, if at all?
Addressing Uncertainty Through Merger Review
If the Bureau wishes to reduce the uncertainty inherent in determining the competitive effects of start-up acquisitions, and mitigate the likelihood of exacerbating that problem by adopting a more flexible standard, Hemphill & Wu suggest that evidence of anti-competitive intent should play an elevated role in helping competition authorities determine whether to permit a nascent acquisition (p. 1882). Evidence of anti-competitive intent may include internal documents, conduct (e.g., an excessive price being offered to the acquired firm), or a pattern of buying nascent competitors.
The Bureau and parliamentarians could consider requiring greater scrutiny of anti-competitive intent as one method for reducing the level of uncertainty in nascent acquisition review. Currently, however, the Bureau’s Feb. 8 submission does not address whether a consideration of intent would be a useful or necessary modification to the more flexible standard.
Abuse of Dominance as an Alternative to Merger Review
Some scholars suggest that the Competition Act’s abuse of dominance provision (s. 79) may serve as a more effective way of targeting anti-competitive nascent acquisitions by dominant firms than merger review under s. 92. Section 79 allows the Competition Tribunal to make an order against a dominant firm engaging in anti-competitive acts which have had, or are likely to have, anti-competitive market effects. Using s. 79 to address “killer acquisitions” would effectively target the same mischief identified by the Bureau in Recommendation 2.3, while preventing the downsides associated with increased legal and commercial uncertainty in nascent acquisition review.
Professor Edward Iacobucci advances this recommendation in another submission to Senator Wetston, also titled “Examining the Canadian Competition Act in the Digital Era.” Iacobucci argues that one benefit of using abuse of dominance to address the anti-competitive effects of nascent acquisitions is that the analysis is ex post: s. 79 evaluates past anti-competitive conduct rather than trying to evaluate what future competition in a market may look like. With the benefit of hindsight, the Tribunal can draw on concrete evidence of anti-competitive effects and get a “better informed picture of the dominant firm’s approach to acquisitions” in an ex post inquiry (Iacobucci, p. 36).
Hemphill & Wu agree that ex post enforcement is important in the context of nascent acquisitions, since at that point there is more information about the adverse effect of the merger and any patterns of anti-competitive nascent acquisitions. They also suggest using laws prohibiting exclusionary conduct to address issues regarding the acquisition of start-up competitors [1], although the authors suggest using both merger review and exclusionary conduct provisions to address the issue.
One apparent downside to using s. 79 as an alternative to merger review for nascent acquisitions is that s. 79’s retroactive approach may make it less effective at preventing anti-competitive acquisitions in the first place. However, Iacobucci argues that a s. 79 abuse of dominance analysis would offer the Commissioner more remedial flexibility to prevent anti-competitive nascent acquisitions than the current s. 92 merger analysis. For instance, the Competition Tribunal could restrict a dominant firm’s ability to acquire nascent competitors in the future if it finds that dominant firm is engaging in a pattern of anti-competitive nascent acquisitions under s. 79. This may more effectively hinder patterns of “killer acquisitions” by dominant tech firms than the alternative where the Commissioner must challenge a series of individual transactions, each considered in isolation. In this way, s. 79 may more effectively target the same mischief that Bureau Recommendation 2.3 seeks to address.
The retrospective nature of the abuse of dominance inquiry reduces the need for adjudicators to engage in speculative inquiries regarding the start-up’s future competitive position, therefore reducing legal commercial uncertainty for parties. Using abuse of dominance as a primary enforcement mechanism can help prevent the negative innovation consequences associated with increased uncertainty, while still targeting dominant firms engaging in anti-competitive nascent acquisitions.
The Bureau’s submission does not address the use of abuse of dominance as either an alternate or additional mechanism to merger review in the context of nascent acquisitions. As such, it remains unclear whether abuse of dominance can, or will, be used to prevent dominant firms from engaging in patterns of nascent acquisitions.
Conclusion
There is much uncertainty and speculation involved when competition authorities try to determine the competitive effects of a merger, and this uncertainty is compounded when one party is a start-up. With the Bureau’s proposed rejection of the strict evidentiary requirements contained in Vancouver Airport Authority in favour of a more flexible standard, the legal uncertainty faced by merging parties may increase even further. If legal uncertainty is not adequately managed, the new “flexible” standard proposed by Recommendation 2.3 may change existing incentives for entrepreneurs and investors, creating unintended consequences for innovation as a result.
Recommendation 2.3 does not discuss how uncertainty will be dealt with, if at all. Some possible methods of reducing uncertainty include using abuse of dominance provisions to address patterns of nascent acquisitions or requiring stronger evidence of anti-competitive intent when reviewing mergers involving start-ups. Whether and how this uncertainty will be addressed remains an open, and important, question for legislators.
* I would like to thank Professor Anthony Niblett for his guidance in helping me think through this post and for discussing the potential innovation effects of Bureau Recommendation 2.3 with me.
[1] Since Hemphill & Wu are writing in the United States, their article specifically refers to using s. 2 of the Sherman Act to address nascent acquisitions. This provision prohibits exclusionary conduct and is similar to the Canadian abuse of dominance provisions.