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Carter Holt Harvey Building Products Group Ltd v The Commerce Commission (New Zealand) [2004] UKPC 37 (14 July 2004)

Privy Council Appeal No. 6 of 2004

Carter Holt Harvey Building Products Group Limited Appellant

v.

The Commerce Commission Respondent

FROM

THE COURT OF APPEAL OF NEW ZEALAND

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JUDGMENT OF THE LORDS OF THE JUDICIAL

COMMITTEE OF THE PRIVY COUNCIL,

Delivered the 14th July 2004

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Present at the hearing:-

Lord Bingham of Cornhill

Lord Hope of Craighead

Lord Scott of Foscote

Baroness Hale of Richmond

Lord Carswell

[Majority judgment delivered by Lord Hope of Craighead]

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This is an appeal from the judgment of the Court of Appeal of New Zealand (Richardson P, Gault and Blanchard JJ), delivered on 5 November 2001 and reported at (2001) 10 TCLR 247, dismissing an appeal by the appellant Carter Holt Harvey Building Products Group Ltd ("Carter Holt") against a judgment of the High Court of New Zealand (Williams J and Professor Ralph Lattimore), delivered on 18 April 2000 and reported at (2000) 9 TCLR 535, upholding a claim by the respondent, the Commerce Commission, that the appellant had contravened section 36 of the Commerce Act 1986.

The events with which this case is concerned took place in 1994. At that time section 36(1) of the Commerce Act 1986 provided:

"No person who has a dominant position in a market shall use that position for the purpose of –

(a) Restricting the entry of any person into that or any other market; or

(b) Preventing or deterring any person from engaging in competitive conduct in that or in any other market; or

(c) Eliminating any person from that or any other market."

The High Court found after a six week trial that a division of Carter Holt, which prior to February 1994 was known as New Zealand Fibreglass Co Ltd but from 1 February 1994 to April 1998 when it was sold to Tasman Building Products Pty Ltd was known as Insulation New Zealand Company ("INZCO"), had used its dominant position in the regional market for building insulation materials in the South Island for the purpose of preventing or deterring a Nelson-based firm called New Wool Products Ltd ("NWP") from engaging in competitive conduct in that market or eliminating it from that market.

The conduct which gave rise to this finding was the supply by INZCO to merchants in the Nelson and Marlborough region from 1 March 1994 of a product known as Wool Line on a "2-for-1" basis, whereby for every bale purchased a second bale would be provided free by INZCO. This was done in response to the introduction into the market in 1992 by NWP of a woollen insulation product known as Wool Bloc which had significantly reduced the sales of INZCO's principal product in that area. A claim that this conduct was also in breach of section 27 of the 1986 Act, which provided that no person shall enter into a contract or arrangement or arrive at an understanding "containing a provision that has the purpose, or has or is likely to have the effect, of substantially lessening competition in a market", was dismissed. In a separate judgment delivered on 5 July 2000, reported at (2000) 9 TCLR 636, the High Court fixed the monetary penalty for the breach of section 36 at $525,000.

In the Court of Appeal INZCO appealed against the determination of the High Court that it had contravened section 36 of the 1986 Act. Its appeal was directed to the High Court's findings on each of the three elements that had to be established in order to show that this section had been breached: (1) that INZCO had a dominant position in the market, (2) that it had used that dominant position and (3) that that use was for the proscribed purpose of preventing or deterring NWP from engaging in competitive conduct in or eliminating it from that market. The Commission cross-appealed against the High Court's determination that the same conduct did not contravene section 27. It also appealed against the High Court's judgment on the amount of the monetary penalty. The Court of Appeal dismissed the appeal by INZCO. The cross-appeals by the Commission were also dismissed.

The appeal which is now before the Board has been confined to a single point only. There is no longer any dispute about any of the primary facts. The findings by the High Court that INZCO was in a dominant position in the South Island regional insulation market and that the "2-for-1" supply was undertaken for the purpose of preventing or deterring NWP from competing in or eliminating it from that market are accepted. The Commission no longer seek to challenge the determination of the High Court on the section 27 claim or on the amount of the monetary penalty. But the narrowing of the range of issues has led to a significant change in the focus of INZCO's attack on the High Court's finding that it used its dominant position in the market for the proscribed purposes.

In the Court of Appeal, as Gault J who delivered the judgment of the court noted (at para 53), INZCO's appeal took the form of a comprehensive attack on the whole assessment of the case by the High Court. It was accepted that there were no significant issues of law involved and that the applicable principles had been correctly identified by Williams J. The appeal was based on the proposition that the finding that each of the three elements in section 36 had been established was contrary to the established principles. Before the Board INZCO's argument was directed more precisely to the causal relationship between dominance and purpose – to the question whether, in order to achieve that purpose, it actually used its position of dominance.

This case is about the consequences of price-cutting. The law of New Zealand does not disable a trader who is in a dominant position in a market from competing with other traders in that or any other market. It is open to the trader to compete on price as well as quality, so long as he does not use his dominant position for the purpose of producing an effect which is anti-competitive. This is the crucial point of principal on which, to their regret, their Lordships find themselves in disagreement with the minority. Moreover, the trader is entitled, before he enters upon a line of conduct which is designed to affect his competitors, to know with some certainty whether or not what he proposes to do is lawful: Telecom Corporation of New Zealand Ltd v Clear Communications Ltd [1995] 1 NZLR 385, 403. The question which lies at the heart of the appeal to the Board is how, in this difficult area, lawful conduct can be distinguished from unlawful conduct.

This question was seen both by Professor Lattimore in the High Court (at para 54) and by the Court of Appeal (at para 75) to be one of degree. INZCO submits, following the advice of the Board in Telecom Corporation at p 403, it was both legitimate and necessary in this case for the court to test the Commission's case by asking whether, when it introduced the "2-for-1" arrangement, INZCO acted in a way which a person not in a dominant position but otherwise in the same position would have acted. INZCO submits that, although this test was referred to in the judgments, neither the High Court nor the Court of Appeal applied it to the facts. As a result they reached a conclusion which could be justified only on the view that the trader who is in a dominant position in the market was under a duty to act in a way which would not be required of a trader who was non-dominant. This, it is submitted, is not what section 36 of the 1986 requires.

As the focus of the case has now been confined to this issue, which – it must be stressed – their Lordships regard as an issue of principle, it is not necessary for the purposes of this judgment to go into the facts in great detail. They are set out with admirable clarity by Williams J in his extensive and careful judgment. The following outline draws upon his findings and the summary of them which is contained in Gault J's judgment in the Court of Appeal.

The facts

The insulation of walls and ceilings is compulsory in New Zealand for all new construction and renovation work. Various materials are used for this purpose, and they come in variety of forms. The materials used include fibreglass, polyester, polystyrene, macerated paper and wool. They are available in mat form, blankets, loose-fill and foam. INZCO was the leading manufacturer of these products in New Zealand. Its main product was a fibreglass or glass wool product which was produced under a licence agreement in manufacturing facilities in Auckland and Christchurch. It was sold, mainly in mat form, under the brand name Pink Batts. INZCO also manufactured and sold a variety of the other products including foil laminates, roof underlays, a polyester product called Comfort Zone and a mineral fibre product called Rocwool.

By the early 1990s INZCO was facing competition from two directions. One was the appearance on the market of insulation products made wholly or partly of natural materials, particularly wool. Wool insulation was developed to meet customer dissatisfaction with the itchiness of fibreglass, health perceptions and the trend towards buying products that had a "green" image. The other was the entry into the New Zealand market of Bradfords, subsidiary of a major Australian company called CSR. It had established a plant in Sydney for the manufacture of insulation products made of glass wool and had appointed a New Zealand distributor for its products which were very competitive with INZCO's products on price and service.

INZCO responded to the competition, including that from Bradfords, by entering into distribution agreements with about 12 major merchant chains which conferred on INZCO the status of preferred but not exclusive supplier of insulation products (Williams J, para 67). A "one stop shop" concept was instituted, with the intention that all types of insulation should be covered by its product range (Williams J, para 59). It developed new products to compete with those offered by its competitors and to comply with the distributors' requests for a wider product range. In June 1993 it changed its name to INZCO from New Zealand Fibreglass to reflect its altered focus. Its relationships with these distributors were regarded by INZCO as of major importance to the continued success of its business. But they were continually under threat of defection, particularly to Bradford (Williams J, para 66).

Competition from wool products came principally from the activities of NWP. It entered the market in March 1992 with a product called Wool Bloc, which was sold for the most part direct to customers. It was deliberately and aggressively promoted as an environmentally friendly product, and its price was set to compete with Pink Batts (Williams J, para 72). By August 1992 NWP's proprietor Mr Newton estimated its market share in the Nelson insulation market as 10%. Merchants became increasingly dissatisfied with INZCO 's range of products. INZCO responded in October 1992 by introducing its polyester product Comfort Zone. But this did little to slow the advance of NWP's marketing of Wool Bloc in the Nelson area where it was taking sales from Pink Batts. The merchants told INZCO's senior management that they were unable to compete without a woollen based product from INZCO which could be claimed to be environmentally friendly and had nothing of the health concerns that were associated with Pink Batts (Williams J, para 113). So INZCO sought to introduce a product which was designed to meet the competition from wool insulation directly. There were major technological problems in developing and manufacturing a suitable product (Williams J, para 91), but in December 1993 INZCO was in a position to market a wool/polyester blend product which it bought in from Autex Industries Ltd for which the brand name that was adopted was Wool Line.

INZCO decided to price Wool Line above that of Pink Batts. This was done in order to recover the cost of production and to allow a margin above cost to it and its distributors. It was also thought that environmentally conscious customers would be willing to pay a premium for it. As a result Wool Line did not attract purchasers in Nelson and sales were slow elsewhere. The merchants in the Nelson area made it plain to INZCO that the product would not find buyers as the pricing was, as one distributor put it, "completely uncompetitive" (Williams J, para 123).

By now Wool Bloc had achieved an estimated 30% of the insulation market in the Nelson/Marlborough area. INZCO was forced to conclude that the launch of Wool Line had been a mistake. It had to placate the merchants, and it had to achieve sales (Williams J, para 129). So it decided to change its pricing for Wool Line in that area. It offered one free bale for every bale purchased – the "2-for-1" offer. The effect of this was to reduce the price for each bale by one half. It was appreciated that the effect was to sell the product at a price which was at least 17-28% below the cost of its production, transport and delivery into store in Nelson (Williams J, para 261). The purpose of the offer was to enable the distributors to compete with Wool Bloc in that region (Williams J, para 137).

The distributors were advised that the offer was effective from 1 March 1994, and that pricing on this basis was to continue for a period of three months to 31 May 1994 when the situation would be reviewed. It was thought that a period of three months would be needed to get Wool Line established in the area by being competitively priced against local operators and to give INZCO time to develop a cheaper and better product. On about 31 May 1994 INZCO decided to extend the initial termination date of the "2-for-1" for a further period of three months. Its marketing manager Mr Trevena-Brown said that he took this step because of pressure from the manufacturer, the continuing need to provide a competitively priced product in Nelson and to give him more time to develop a similar but cheaper product (Williams J, para 147). The offer was also extended to Queenstown (Williams J, para 260).

Meantime, at the beginning of 1994, NWP decided to increase the price of Wool Bloc by 12%. There is no evidence that INZCO was aware of this at the time (Williams J, para 148). Mr Newton said that this increase was not sparked off by increased costs or anything of that kind. In March 1994 he heard rumours of INZCO's "2-for-1". Having confirmed the existence of the offer by making anonymous calls to builders and merchants, he complained to the Commission on 22 March 1994. On 8 April 1994 the Commission wrote to Mr Newton informing him of its decision to proceed. INZCO was unaware of this until 24 June 1994 when the Commission wrote to it saying that it was inquiring into allegations that it had breached sections 27 and 36 of the 1986 Act and seeking information for use in its inquiries (Williams J, para 153).

The senior management of INZCO was conscious of its commitment to the merchants about the price of Wool Line and the need to maintain the "one stop shop" product range. So it was decided not to terminate the "2-for-1" at that stage but to allow it to run on to the then planned expiry date which was 31 August 1994. It remained in place after that date but, after an intervention by the senior management of Carter Holt who had by now become aware of the Commission's investigation, INZCO decided to end the "2-for-1" on 27 September 1994 (Williams J, para 160). It was accepted that it was contractually obliged to supply Wool Line at that price to fulfil orders lodged with merchants by their customers before the change in the price structure was notified.

The reduction in the price of Wool Line had the desired effect on INZCO's turnover. Sales of Wool Line picked up, especially in the area where the "2-for-1" operated. At or about the same time there was a sharp drop in the sales of NWP's product Wool Bloc. The reason for this could not be precisely determined, in view of NWP's decision to raise its price at a time very close to the introduction of the lower price for Wool Line and the various other factors summarised by Gault J in the Court of Appeal (para 15). NWP had been free to sell its product through merchants if it wanted, but it had made a commercial decision not to do so (Williams J, para 83). In view of the drop in sales it decided to cease production of Wool Bloc during the period when the "2-for-1" was still operating. When Wool Line was restored to its original pricing it remained an unsatisfactory product for INZCO. While Wool Bloc remained on the market merchants complained once more to INZCO that it was uncompetitive (Williams J, para 165).

The South Island retail insulation market at this time was intensely competitive. There were a large number of independent sellers in the Nelson/Marlborough region, some with several outlets, who were striving to maximize their market share over the entire range of insulation products. It is probable that, if NWP's ability to remain in business had been ended by the "2-for-1", another wool-based product similar to Wool Bloc would have been available within a short time. Merchants would have marketed such a product if it was worth their while to do so (Williams J, paras 288-289)

The section 36 cause of action: introduction

The following points which are relevant to the case under section 36 emerge from this summary:

(a) Although INZCO was in a dominant position in regional market for insulation in the South Island, it was not immune from competition from others in that market.

(b) Sales of its principal product Pink Batts had been suffering since 1992 in the Nelson/Marlborough area where it was especially vulnerable due to the introduction into the market of Wool Bloc, a wool based product, by NWP.

(c) INZCO was at risk of losing the support of the merchants on whom it relied for the marketing of its products because it was not providing them with an environmentally friendly product which could compete with Wool Bloc.

(d) INZCO introduced its own wool-based product, Wool Line, in response to pressure from its merchants for a competitive product of this type. It was originally priced above Pink Batts. When pricing at this level proved to be uncompetitive, the price was reduced by offering 2 for 1 to enable the merchants to compete with Wool Bloc.

(e) There was no evidence that it was INZCO's intention to use its market power to obtain super-profits from the sales of Wool Line. Its aim was to maintain its share in the market for the sale of its principal product Pink Batts by offering a complete range of insulation products, including a wool-based product, to its distributors at prices which were competitive.

There is no longer any challenge to the decision of the High Court on the issues of dominance and of purpose. So the critical question is whether the court was entitled to come the conclusion that it did on the issue of use. As the Board sought to emphasise in Telecom Corporation of New Zealand Ltd v Clear Communications Ltd [1995] 1 NZLR 385, 402, the meaning and effect of section 36 of the 1986 Act is that use of a dominant position otherwise than for one of the proscribed purposes does not constitute a breach. Nor does the fact that a person has acted in order to achieve one of the proscribed purposes constitute a breach unless he has used his dominant position to achieve those purposes. The minority say that the purpose of section 36 is to prevent use of a dominant position for the purpose of stifling competition. But it has to be borne in mind, as the Board also pointed out at p 402, that a monopolist is entitled like everyone else to compete with his competitors. He is not required to stand idly by as he sees his market share being eaten into by others who are not dominant. That would be stifling competition – the very thing the section is designed to promote, for the consumer's benefit. Moreover a breach of the Act will expose the dominant trader to a quasi-criminal penalty. The law would be failing in its duty if it did not make it clear to him what he can and cannot do when he is in that predicament.

As Mason CJ and Wilson J explained in Queensland Wire Industries Pty Ltd v Broken Hill Pty Co Ltd (1989) 167 CLR 177, 191, the operation of section 46 of the Trade Practices Act 1974, which provided the model for section 36 of the 1986 Act in New Zealand which achieves the same effect albeit in different language, is predicated on the assumption that competition is a means to the end of protecting the interests of consumers:

"Competition by its very nature is deliberate and ruthless. Competitors jockey for sales, the more effective competitors injuring the less effective by taking sales away. Competitors almost always try to 'injure' each other in this way. This competition has never been a tort (see Keeble v Hickeringill (1809) 11 East 574) and these injuries are the inevitable consequence of the competition section 46 is designed to foster. In fact, the purpose provisions in section 46(1) are cast in such a way as to prohibit conduct designed to threaten that competition – for example, section 46(1)(c) prohibits a firm with a substantial degree of market power from using that power to deter or prevent a rival from competing in a market. The question is simply whether a firm with a substantial degree of market power has used that power for a purpose proscribed in the section, thereby undermining competition, and the addition of a hostile intent inquiry would be superfluous and confusing."

This is the background to the advice which the Board gave in Telecom Corporation of New Zealand Ltd v Clear Communications Ltd [1995] 1 NZLR 385, 403 that it cannot be said that a person in a dominant market position "uses" that position for the purposes of section 36 if he acts in a way which a person not in a dominant position but otherwise in the same position would have acted. INZCO's decision, first to introduce Wool Line and then to reduce its price by offering 2 for 1, was taken in the face of the competition which it was facing from NWP and in response to demands from its distributors for a wool-based product that they could sell at prices that were competitive. It is hard to see how they could have maintained their market share if they had not responded to these demands. Again it must be stressed that it is not the purpose of section 36 to deny to a person who is in a dominant position in the market the opportunity to protect his market share when his position is threatened by competitors. Close attention must therefore be given to the process of reasoning which led the High Court, and in its turn the Court of Appeal, to conclude that in instituting and maintaining the "2-for-1" pricing for Wool Line INZCO engaged in unlawful conduct because it used its dominance in the market for the supply of insulation in the South Island regional market for the proscribed purposes.

The judgments of the courts below on the " use" of dominance

(a) Williams J

Williams J dealt with this issue in a section of his judgment which was headed "Use of Dominance and Purpose of Use". Their Lordships cannot help thinking, with respect, that it would have been better if he had dealt with the issues of use and of purpose separately, and if he had dealt with them in the order in which these issues are mentioned in section 36. They have in mind the Board's warning in Telecom Corporation of New Zealand Ltd v Clear Communications Ltd [1995] 1 NZLR 385, 402 that, although it is legitimate to infer "purpose" from use of a dominant position producing an anti-competitive effect, it may be dangerous to argue the converse – that is to say, that because the anti-competitive purpose was present therefore there was use of a dominant position.

The first part of this section is devoted to the issue of purpose (paras 248 and following). Williams J said that a case had been made out for holding that INZCO was endeavouring to prevent NWP from engaging in competitive conduct in the South Island regional market for insulation or, more pertinently, of eliminating it from that market (para 250). The reasons for this conclusion are discussed in the following paragraphs. There was some evidence that when they were setting the price of Wool Line in December 1993 senior management of INZCO were focusing on Thermofleece and not on NWP and Wool Bloc. But Williams J found as a fact that over the next three months the focus shifted away from any concentration there may have been on Thermofleece and that it became fixed on eliminating Wool Bloc or preventing or deterring it from engaging in further competitive conduct on the South Island regional insulation market (para 256). He also found that INZCO's senior management knew that their actions were not merely matching Wool Bloc on price but were undertaken in the knowledge that the "2-for-1" would substantially undermine the sales of Wool Bloc because they knew that Wool Bloc was not being marketed through merchants and that most insulation buyers purchased their products through merchants rather than directly from manufacturers (para 264).

It is only now, in the middle of para 264, that Williams J turns his attention to the use of dominance as a distinct issue. He makes the point that INZCO was relying not just on merchants' commercial necessity to sell Wool Line but on the close contractual and personal relationships which INZCO had fostered with merchants at all levels and the geographical focus of the "2-for-1", and its knowledge that once this price regime was instituted it was virtually certain that at least one merchant would cut his price for Wool Line and that all others would be forced to follow. His entire process of reasoning on the issue of use appears in the final sentences of this paragraph:

"Those factors in combination show clearly that INZCO knew that the '2-for-1' price would be passed on by merchants, at least in Nelson/Marlborough, for the benefit of the public, INZCO and the merchants and to the detriment of New Wool Products and Wool Bloc. All those factors also show that in instituting the '2-for-1' Messrs Trevena-Brown and Peters [INZCO's senior management] intended that INZCO would use its dominant position for the purpose of preventing or deterring New Wool Products from continuing to compete with it in the South Island insulation market or of eliminating it from that market. In terms of sections 2(1A) and 2(5)(b) the '2-for-1' was plainly a substantial purpose. It was plainly real and halving the price was plainly substantial."

It is to be noted that nowhere in this discussion does Williams J direct his attention to the question which in Telecom Corporation of New Zealand Ltd v Clear Communications Ltd [1995] 1 NZLR 385, 403 the Board said it was both legitimate and necessary to consider, which is how the hypothetical seller would act in a competitive market ("the counterfactual test"). It asks whether a hypothetical firm which was not in a dominant position but was otherwise similarly placed could rationally have acted as the dominant firm did. This is a significant omission. As their Lordships have already indicated, it is by no means self-evident that INZCO would have behaved any differently if it had not been in a dominant position in the market when it was deciding what it should do to meet the competition which it was facing in that market from Wool Bloc. It would have been presented with the same complaint that the price which was originally set for Wool Line was uncompetitive. The obvious response, in a truly competitive market, was to cut the price of Wool Line to a level that was competitive.

Williams J dealt with the issue of predatory pricing and recoupment in the next section of his judgment (paras 266 and following). The background to this topic, and an explanation for the omission of the counterfactual test, is to be found in an earlier section of his judgment where he examines the law on the section 36 cause of action (paras 14 and following).

In paras 27 and 28 of his judgment Williams J quoted the passage in Telecom Corporation of New Zealand Ltd v Clear Communications Ltd [1995] 1 NZLR 385, 403 where the counterfactual test is set out. But he then appears to distance himself from it. He noted that in Port Nelson Ltd v Commerce Commission [1996] 3 NZLR 554, 577 the Court of Appeal observed that it was not easy to see why use of a dominant position should not be determined as simply a question of fact without the need to postulate artificial scenarios, and then added this comment:

"The Court of Appeal presumably took that view because there is little conduct which would contravene section 36 if the test were to be that a firm could not be using its dominant position if it acted in the same way as one not in a dominant position but otherwise in the same circumstances would act. In particular, predatory pricing would be excluded under such a test because a reduction in prices, without proof of the elements of section 36, is pro- rather than anti-competitive …"

Having apparently reached the view that it was not necessary to apply the counterfactual test, Williams J turned at para 33 to the issue of predatory pricing. He took as his starting point INZCO's admission that the "2-for-1" involved it in selling the second bale of Wool Line at below production cost. The theme for his examination of the authorities that follows is then set by the following observation:

"There is no legal reason why firms cannot sell below an appropriate measure of cost unless it is done, 'for the purpose of eliminating competitors in the short run and reducing competition in the long run' (Cargill Inc v Montfort of Colorado Inc (1986) 479 US 427 cited in Gault [on Commercial Law] para CA36.20(1) p 3-158) or, to put it more precisely, if the 'predatory' pricing has one of the purposes proscribed by section 36."

The citation of authority that follows begins with a further quotation from the judgment of the Court of Appeal in Port Nelson where the issue of predatory pricing was discussed in the context of section 27, as there was no use of a dominant position in that case. Section 27 is breached if the seller enters into a contract or arrangement, or arrives at an understanding, containing a provision "that has the purpose, or has or is likely to have the effect, of substantially lessening competition in a market." If it does have that purpose the activity in question can in that context, of course, properly be described as predatory.

Williams J noted that in Port Nelson [1996] 3 NZLR 554, 572 the Court of Appeal accepted that below cost pricing will not frequently give rise to competition concerns, as the reduction of prices generally "will reflect competition at work". But he drew attention also to the following passage in its judgment at p 571, where the court indicated that such conduct may contravene section 27 without the trader necessarily having the market power to maintain those prices until the competition is eliminated and then recoup the losses by increasing prices after the competition has gone:

"The mere fact that a participant operates in the market at a loss, and even fails, will not necessarily lessen competition. But conduct that does lessen competition will contravene even in the absence of evidence of the ability ultimately to recoup the loss – though that may generally be presumed from a decision to indulge in anti-competitive conduct."

Williams J does not explain how that observation, which was made in the context of section 27, is to be applied to a case about pricing which is brought under section 36, bearing in mind the Board's warning in Telecom Corporation of New Zealand Ltd v Clear Communications Ltd [1995] 1 NZLR 385, 402 that it may be dangerous to infer from evidence that an anti-competitive purpose was present that there was "use" of a dominant position.

In the absence of any previous cases about price-cutting in New Zealand, Williams J turned to authorities from other jurisdictions on this point. He referred first to three cases from Australia (paras 35-39): Victorian Egg Marketing Board v Parkwood Eggs Pty Ltd (1978) ATPR 17,783; Eastern Express Pty Ltd v General Newspapers Pty Ltd (1992) 106 ALR 297; and the decision of Heerey J in Australian Competition and Consumer Commission v Boral Ltd (1999) 166 ALR 410.

Victorian Egg Marketing Board was a case, like Port Nelson, where the predation took place in a market in which the predator was not dominant. In that case Bowen CJ said that it might be that where one can infer the requisite purpose from other evidence price cutting may be regarded as predatory, notwithstanding that it is not below marginal or average variable cost and does not result in a loss being incurred. In Eastern Express, at p 326, Lockhart and Gummow JJ said of predatory pricing that it was for the judge to decide whether the existence of a proscribed purpose may properly be inferred, with or without the aid of other evidence, from evidence of the conduct of the corporation in relation to the prices it charged. In Boral Heerey J observed at p 442, para 166, that it would be anti-competitive if a firm with a substantial degree of market power has engaged in price cutting so that competitors will exit the market so that in due course it will more readily enjoy the advantages of market power and recoup its losses. This, he said, was consistent with the basic propositions that section 46 of the Trade Practices Act 1974 exists to protect competition and consumers, not competitors, and that neither price cutting (to whatever level) nor ruthless competition, nor conduct designed to injure competitors, is necessarily unlawful: para 167. At p 443, para 173, he said:

"To recapitulate, selling below cost plus recoupment by supra-competitive pricing equals predatory pricing. Absent the second element, or at least the hope or expectation thereof, there is no more than ruthless competitive conduct which the TPA does not forbid, but rather promotes."

Williams then referred to three decisions of the European Court of Justice which were relied on by Mr Brown QC for the Commission (paras 41-43): Akzo Chemie BV v EC Commission [1993] 5 CMLR 215; Tetrapak International SA v EC Commission [1997] 4 CMLR 662; and Compagnie Maritime Belge NV and Dafra Lines v Commission of the European Communities (29/10/98 Joined Cases C-395/96P and C-396/96P). He quoted a passage from Akzo where the ECJ said at p 281, para 71, that prices below variable costs by means of which a dominant undertaking seeks to eliminate a competitor must be regarded as abusive, as a dominant undertaking has no interest in applying such prices except that of eliminating competitors so as to enable it to raise its prices by taking advantage of its monopolistic position. In Tetrapak the ECJ upheld the decision of the Court of First Instance, which declined to lay down the prospect of recouping losses "as a new pre-requisite" for establishing the existence of predatory pricing, observing, at p 724, para 44, that it must be possible to penalise predatory pricing whenever there is a risk that competitors may be eliminated.

Williams J did not indicate at the end of this section of his judgment what conclusions he drew from these authorities. But the effect which they had on his approach to the case can be seen from what he said in para 269, which appears at the end of the section where he examined the issues of use of dominance and purpose of use:

"Accordingly the Court holds that INZCO, through Messrs Trevena-Brown and Peters, intended to predate New Wool Products but did not engage in predatory pricing in the normal sense. It engaged in behaviour which was predatory in the sense that the behaviour of Akzo and the Victorian Egg Marketing Board was predatory. It priced a comparable product at a level and in circumstances which it knew would undermine a rival's business and preserve a highly profitable product [Pink Batts] from further harm."

It will be recalled that the European Court of Justice held in Akzo that it was sufficient to establish a case of abuse that the dominant undertaking was seeking to eliminate a competitor – in other words, proof that that was its purpose was sufficient to show that the price cutting was predatory. In Victorian Egg Marketing Board the High Court said that where one could infer the requisite purpose from other evidence the inference could be drawn that the price cutting might be predatory. Their Lordships will explain in a later section of this judgment why the European cases cannot be relied on as a sound guide to cases brought under section 36 of the 1986 Act in New Zealand. The decision in Victorian Egg Marketing Board has, of course, now to be read in the light of the later decisions of the High Court of Australia, notably Queensland Wire Industries Pty Ltd v Broken Hill Proprietary Co Ltd (1989) 167 CLR 177 and Boral Besser Masonry Ltd v Australian Competition and Consumer Commission (2003) 195 ALR 609, affirming the decision of the Federal Court in Australian Competition and Consumer Commission v Boral Ltd (1999) 166 ALR 410.

Their Lordships are left with the strong impression that Williams J overlooked the warning which the Board gave in Telecom Corporation of New Zealand Ltd v Clear Communications Ltd [1995] 1 NZLR 385, 402 that, while it is legitimate to infer "purpose" from use of a dominant position producing an anti-competitive effect, it may be dangerous to argue the converse that because the anti-competitive purpose was present, therefore there was use of a dominant position. This is because the effect of preventing a monopolist from competing with its competitors like everyone else would be to protect inefficient competitors. It appears that Williams J decided to draw the inference, simply from the fact that INZCO was in a dominant position because of its relationship with its distributors and its purpose was a proscribed purpose, that it had "used" its dominant position for that purpose.

(b) Professor Lattimore

Professor Lattimore introduced his supplementary judgment with the statement that he was in full agreement with the facts as stated by Williams J in his reserved judgment (para 1). He then set out his reasoning on the issues of dominance, barriers to entry, use of dominance and purpose of dominance in a series of separate sections. It is not possible to do full justice to his reasoning in short summary. But it is possible to extract from the section on the use of dominance the essential part of it that led him to conclude that INZO has used its dominance for the proscribed purposes.

The key passages in this judgment appear in paras 50, 51 and 54. In para 50 Professor Lattimore said that the sale in the Nelson region by INZCO of its wool-type product, which it introduced to compete with Wool Bloc, at a very significant margin below its variable cost of production was the action of a dominant supplier that would not be carried out by a non-dominant supplier in these circumstances. In para 51 he said that INZCO could recoup the cost of the Wool Line special pricing arrangement if the scheme meant that NWP was constrained from expanding in the market or eliminated from it. This recoupment would take the form of maintaining the list prices of Pink Batts at levels that were otherwise threatened by NWP, and at the same time increasing its market share for Pink Batts and other INZCO products. In para 54 he said that promotions have three dimensions: the extent to which the price is below cost, the length of time the promotion operates and the quantity of the product supplied through the promotion. It was not reasonable to limit the extent of the price cut, and promotions could take place over an extended period of time. But promotional arrangements by dominant firms could not involve such a large proportion of total market demand over a given time period that they cause significant harm to the sales of competitors as that would be predatory.

He expressed his conclusion in the final sentence of para 54:

"In this case it is the combined effect of targeting NWP and of pricing 30-40 percent below variable cost over a period of months for a significant quantity of Wool Line that constitutes misuse of dominance."

In para 56 he observed that the "2-for-1" pricing arrangement was in place for 7 months before it was officially stopped, adding that this was a very long period of time for a promotion that involved pricing 30-40 percent below average variable cost on a significant quantity of product in the market.

Professor Lattimore said in para 50 of his judgment that a non-dominant firm would not have reduced its price by such a margin below variable cost as INZCO did. This is a reference to the counterfactual test. But the comparison which he makes appears, with respect, to be incomplete. In an earlier passage he accepts that it was rational for INZCO to continue with Wool line because it gave it the range of products that distributors required and helped to keep out other products (para 25). If it was rational for INZCO to do this in the face of competition from Wool Bloc, it would have been rational too for anyone else who was facing the same competition and was seeking to meet the demands of its distributors. In para 25 he makes the point that the profitability of the "2-for-1" for Wool Line was dependent on the price performance of Pink Batt sales over which INZCO had a high degree of market control. In other words, INZCO could afford to lose money on Wool Line because of its financial strength elsewhere.

Williams J put this point into its proper context when he accepted that the cost to INZCO (between $67,000 and $130,000) was immaterial to a company of INZCO's size selling a relatively small volume product in a limited geographical area (para 200). Financial strength may or may not be the result of dominance in the relevant market. The dominant firm is not required, when it is considering in the face of competition the extent to which it is legitimate for it to cut prices, to disregard its financial strength. That would place it at a disadvantage, which others of equal or greater financial strength would be free to exploit. An accurate application of the counterfactual test required a comparison to be made between the actions that would be undertaken by firms of equal financial strength, differing only as to whether they were or were not dominant.

The origins of Professor Lattimore's process of reasoning are to be found in an earlier passage in his judgment where he examined the question of price control. In para 15 he said that, where there is a market with a dominant firm, the dominant firm essentially controls and sets the market price. In para 16 he said that in the meaning of the 1986 Act a competitive price was one determined by a market in which, among other things, there is no dominant firm. This led him to conclude:

"The Act promotes behaviour where the participants in markets are competitive in the sense that the market is either highly contestable, workably competitive or near perfectly competitive. This is the economics meaning of the term."

In para 17 he said that it followed that in this case there was no price matching defence to allegations of predatory pricing. Setting a price which matched the price of the product of another firm – "price aping", as he called it – could imply the use of dominance. It is hard to reconcile this process of reasoning with the Board's advice in Telecom Corporation of New Zealand Ltd v Clear Communications Ltd [1995] 1 NZLR 385.

(c) The Court of Appeal

The Court of Appeal dealt with the issue of use of dominance in paras 72-77 of its judgment. It prefaced its consideration of this issue with some comments on the appropriate approach. The question to which it directed its attention was whether it was necessary to employ the counterfactual test as indicated in Telecom Corporation of New Zealand Ltd v Clear Communications Ltd [1995] 1 NZLR 385 and Queensland Wire Industries Pty Ltd v Broken Hill Proprietary Co Ltd (1989) 167 CLR 177. It recalled its observations on this issue in Port Nelson which Williams J noted at para 28 of his judgment, and noted (in para 74) without further comment at this stage that Williams J did not expressly employ the counterfactual test. On the other hand, it said, Professor Lattimore did set out why he considered INZCO went beyond what a firm not in a dominant position would have done. The remainder of this section is taken up with the Court's examination and approval of the approach taken to this issue by Professor Lattimore.

The Court rejected INZCO's argument that among the circumstances which were to be postulated for a non-dominant firm but otherwise in the same position as INZCO was a firm with the same distribution structure (para 75). This was because the distribution structure was seen as an important factor in contributing to INZCO's dominant position. The Court also said that in a competitive market INZCO would not have "super-profits" from high margins on the Pink Batts product from which to subsidise below-cost trading in another product (para 76). The mention of super-profits in this paragraph is a reference to Professor Lattimore's finding (para 24) that INZCO was getting high gross margins on Pink Batts which constituted a very high proportion of its sales, and his conclusion (para 41) that INCZO's very high market share enabled it to control the prices and sales of Pink Batts and its other products to a very high degree. The Court of Appeal concluded its discussion of this issue with these words (para 77):

"We are not persuaded that in his assessment Professor Lattimore erred in concluding that the extent of the below-cost pricing and the period over which it operated meant that INZCO went beyond what a non-dominant firm would have done. The 2-for-1 strategy was adopted, in a practical and commercial sense, because INZCO was in a dominant position in the supply market."

As their Lordships have already noted, the key to Professor Lattimore's approach seems to lie in his view that price aping, as he called it, by a dominant firm could imply the use of dominance (para 17). He saw the question as one of degree, and it was the combined effect of the factors of extent, length of time and quantity that led him to draw the inference that there had been a misuse by INZCO of its dominance. The Court of Appeal endorsed his approach. This raises what has become the central issue in this appeal. INZCO's submission is that neither the High Court nor the Court of Appeal applied the counterfactual test and that the conclusion which they reached can be justified, if at all, only by dispensing with the need for any causal connection between the dominant position and the anti-competitive consequences. This, it is said, is consistent with the approach which is taken to this issue in the competition law in EC law but is not part of the competition law of New Zealand or Australia.

The "counterfactual" test

It is evident that the courts below showed a marked lack of enthusiasm for what has come to be known as the counterfactual test. The justification for it needs to be re-examined in the light of this challenge to its relevance and utility.

The starting point is to be found in the principle that competition is in the public interest. It lies at the heart of the 1986 Act. The object of section 36, like its counterpart in Australia, is to protect the interests of consumers. It is predicated on the assumption that competition is a means to that end: Queensland Wire Industries Pty Ltd v Broken Hill Proprietary Co Ltd (1989) 167 CLR 177, 191, per Mason CJ and Wilson J. A dominant firm is as free to compete in the market as a firm that is non-dominant, so long as it does not act in an anti-competitive manner by abusing its position of dominance. With this in view, the section is carefully worded. The word "use" requires that a causal relationship is shown between the conduct which is alleged against the dominant firm and its dominance or market power. Only if that connection is shown can it be said that its conduct is a use of that dominance: National Australia Bank Ltd v Boral Gerrard Strapping System Pty Ltd (1992) 111 ALR 631, 637 per French J.

It follows that if a dominant firm is acting as a non-dominant firm otherwise in the same position would have acted in a market which was competitive it cannot be said to be using its dominance to achieve the purpose that is prohibited. That is the basis on which the counterfactual test is founded. As Wilcox J said in Eastern Express Pty Ltd (1991) 103 ALR 41, 65, it would be surprising if Parliament intended to proscribe conduct by a company with sufficient resources to compete effectively. Something more than that is required.

The issue requires particular care where, as in the present case, the impugned conduct consists of price-cutting. Boral Besser Masonry Ltd v Australian Competition and Consumer Commission (2003) 195 ALR 609, affirming the decision of the Federal Court in Australian Competition and Consumer Commission v Boral Ltd (1999) 166 ALR 410, was such a case too. Among the steps which Boral and its subsidiary Borral Besser Masonry Ltd were alleged to have taken in the face of competition in the market was to sell their concrete masonry products at less than the avoidable cost of production. It was held that the subsidiary did not have market power in the market. So the Commission's case failed both at first instance and in the High Court of Australia on the issue of what section 36 of the 1986 Act calls dominance. But the case is of interest because of the observations that the judgments contain about the counterfactual test and the concept of predatory pricing. They show that the margin between legitimate competition and anti-competitive conduct is not crossed by the lowering of prices. It is crossed when the dominant firm uses its ability to raise prices without losing its market share.

In the Federal Court at p 440, para 158, Heerey J said that if the impugned conduct has a business rationale, that is a factor which points against any finding that the conduct constitutes a taking advantage of market power:

"If a firm with no substantial degree of market power would engage in certain conduct as a matter of commercial judgment, it would ordinarily follow that a firm with market power which engages in the same conduct is not taking advantage of its power."

These observations were approved by the High Court in Boral Besser Masonry Ltd v Australian Competition and Consumer Commission (2003) 195 ALR 609, by Gleeson CJ and Callinan J at p 643, para 170 of their judgment.

Mindful of the need for caution in translating United States judgments to the interpretation of Australian law, Heerey J observed at p 441, para 161, that an essential element of the concept of predatory pricing in United States anti-trust law under section 2 of the Sherman Act was the recoupment of losses by the subsequent charging of supra-competitive prices. Among the passages that he quoted from cases under the Sherman Act was one from Barry Wright Corp v ITT Grinnell Corp (1983) 724 F 2d 227, 231 where Judge Breyer (now an Associate Justice of the United States Supreme Court) sitting in the Court of Appeals for the First Circuit, said:

"…one must ask why the Sherman Act ever forbids price cutting. After all, lower prices help consumers…. a legal precedent or rule of law that prevents a firm from unilaterally cutting its prices risks interference with one of the Sherman Act's most basic objectives: the low price levels that one would find in well-functioning competitive markets.

Despite these considerations, courts have reasoned that it is sometimes possible to identify circumstances in which a price cut will make consumers worse off, not better off … Suppose, for example, a firm cuts prices to unsustainably low levels – prices below 'incremental costs'. Suppose it drives competitors out of business, and later raises prices to levels higher than it could have sustained had its competitors remained in the market. Without special circumstances there is little to be said in economic or competitive terms for such a price cut."

Heerey J concluded at p 442, para 167 that predatory pricing contravenes section 46 if the firm has engaged in that conduct so that competitors will exit the market, so that in due course it will more readily enjoy the advantage of power and recoup its losses by raising prices.

This approach was confirmed by the High Court in Besser Masonry Ltd v Australian Competition and Consumer Commission (2003) 195 ALR 609. In their judgment at p 632, para 123, Gleeson CJ and Callinan J said:

"… where the conduct alleged to contravene section 46 is competitive pricing, it is especially dangerous to proceed too quickly from a finding about purpose to a conclusion about taking advantage of market power (Melway Publishing Pty Ltd v Robert Hicks Pty Ltd (2001) 205 CLR 1, 18-19, para 31; Telecom Corp of New Zealand Ltd v Clear Communications Ltd [1995] 1 NZLR 385, 402). Indeed, in such a case, a process of reasoning that commences with a finding of a purpose of eliminating or damaging a competitor, and then draws the inference that a firm with that objective must have, and be, exercising, a substantial degree of power in a market, is likely to be flawed. Firms do not need market power in order to put their prices down; and firms that engage in price-cutting, with or without market power, cause damage to their competitors. Where, as in the present case, a firm accused of contravening section 46 asserts that it is operating in an intensely competitive market, and that its price and behaviour is explained by its response to the competitive environment, including the conduct of its customers, an observation that it intends to damage its competitors, and to do so to such a degree that one or more of them may leave the market, it is not helpful in deciding whether the firm has, and is taking advantage of, a substantial degree of market power."

In a later passage in the same judgment the point is made that financial strength is not market power: p 635, para 138. At p 636, para 139 Gleeson CJ and Callinan J said:

"There can be circumstances in which price-cutting may be undertaken by a powerful firm, or combination of firms. But the ability to cut prices is not market power. The power lies in the ability to target an outsider without fear of competitive reprisals from an established firm, and to raise prices later."

McHugh J, in a separate but concurring judgment, examined the question of market power and predatory pricing. In part his discussion of this issue is directed to the question whether engagement in predatory pricing was evidence of market power. But he also dealt with the question whether recoupment was a necessary element of a successful claim of predatory pricing. Drawing on the United States jurisprudence and the definition of predatory pricing by the United Kingdom Office of Fair Trading, he said at p 667, para 278 that to require recoupment as a necessary element of predatory pricing claim fitted in with the terms of section 46. This was not only where the question is whether the firm had market power. It also bore on the question whether it can be said that a firm which has substantial market power has taken advantage of that power.

As McHugh J put it at p 668, para 279, the conduct must have given the firm with market power some advantage that it would not have had in the absence of its substantial degree of market power. He developed this point at p 668, para 280, where he said:

"In a competitive market, the more efficient firms can produce more (because their average costs are lower) and obtain a greater share of the market with the result that they substantially damage their less efficient competitors. Such firms can expand their production until their marginal cost equals the market price. No one would suggest that an efficient firm with market power breaches the section because it increases its output to the level of its marginal cost. Yet the firm has market power, has substantially damaged its competitors and by intentionally increasing its output must have acted for a proscribed purpose. It does not breach s 46, however, because it has not 'taken advantage of' its market power. It has not sought to act in a manner 'free from the constraints of competition' (Melway Publishing Pty Ltd v Robert Hicks Pty Ltd (2001) 205 CLR 1, 27, para 67 per Gleeson CJ, Gummow, Hayne and Callinan J). Its market power is irrelevant. Similarly, when a firm cuts prices, it does not act 'free from the constraints of competition'. Its market power, if it has any, is not connected with its conduct. On the other hand, if it has substantial market power and cuts prices below cost for a proscribed purpose with the intention of later recouping its losses by using its market power to charge supra-competitive prices, it has taken advantage of its market power to cut prices below cost to damage competitors."

The following propositions can be extracted from these authorities:

(a) It is, as the Board said in Telecom Corporation of New Zealand Ltd v Clear Communications Ltd [1995] 1 NZLR 385, 403, both legitimate and necessary when giving effect to section 36 to apply the counterfactual test to determine whether the defendant has used its position of dominance.

(b) However, the use by a dominant firm of its financial ability to cut prices must be distinguished from its use of its position of dominance, the measure of which is its market power. The financial ability to cut prices is not market power: Boral Besser Masonry Ltd v Australian Competition and Consumer Commission (2003) 195 ALR 609, 635, para 138. Cutting prices only becomes unlawful when the dominant firm is shown to have done so by use of its position of dominance.

(c) A dominant firm uses its position of dominance when it engages in price-cutting with a view to recouping its losses without loss of market share by raising prices without fear of reprisals afterwards: Boral Besser, p 636, para 139.

The EC cases

In view of the extent to which Williams J relied on the European cases in support of his judgment that INZCO used its dominance in instituting and maintaining the "2-for-1", it is necessary to consider how far, if at all, it is safe to rely on these cases in the context of the 1986 Act.

Article 86 of the Treaty establishing the European Community (now Article 82 EC) provides that any abuse by one or more undertakings of a dominant position within the common market or in a substantial part of it shall be prohibited as incompatible with the common market in so far as may affect trade between Member States and that such abuse may, in particular, consist in directly or indirectly imposing unfair purchase or selling prices or other unfair trading conditions.

At first sight this Article has the same purpose and effect as section 36 of the 1986 Act. But in Akzo Chemie BV v E C Commission [1993] CMLR 215, 238 Advocate General Lenz pointed out that according to the case law of the European Court of Justice, but contrary to the literal sense of Article 86, there need not be any relationship of cause and effect between the dominant position and its abusive exploitation. "In particular," he said, "Article 86 does not require that the dominant undertaking in the market should have used its economic power to bring about the abuse". This statement is directly contrary to what section 36 requires according to the New Zealand and Australian authorities.

In Bellamy & Child, European Community Law of Competition (5th edition, 2001), para 9-068 the state of the Court's jurisprudence is explained in this way:

"Conduct which may be permissible in a normal competitive situation may amount to an abuse if carried out by dominant firms because such firms have a 'special responsibility' on account of the prejudice that their activities may cause to competition in general and to the interests of competitors, suppliers, customers and consumers. It follows from the nature of the obligations imposed by Article 82 that undertakings in a dominant position may be deprived of the right to adopt a course of conduct or take measures which are not in themselves abuses and which would even be unobjectionable if adopted or taken by non-dominant undertakings."

In para 9-069 it is noted that in Compagnie Maritime Belge NV and Dafra Lines v Commission of the European Communities (29/10/98 Joined Cases C-395/96P and C-396/96P), at para 114 the Court appeared to endorse the suggestion by Advocate General Fennelly in para 132 of his opinion that for undertakings that are near-monopolists conduct which is demonstrably intended to prevent the emergence of any competition may be assessed according to a higher standard, holding the "actual scope of the special responsibility" depends on the specific circumstances of each case.

Their Lordships hold, in the light of this description of the way Article 82 has been applied by the European Court, that it is unsafe for any conclusions to be drawn in the context of section 36 of the 1986 Act as it must be applied in New Zealand from the decisions of that court in cases brought by the EC Commission under that Article.

Conclusion

Their Lordships are mindful of the fact that they have been called upon to review the decision of an expert tribunal and of the Court of Appeal whose judgment was prepared by an acknowledged master in this field. They are reluctant to differ from their conclusions. It hardly needs to be said that they would not have done so if the issues in this appeal had been confined to issues of fact. But there is, as they have explained, an important issue of principle and the extent to which competition law should inhibit price-cutting by dominant firms is known to be a difficult area. The public interest lies in preserving the ability of firms to compete with each other in a competitive market, on price as well as on quality. It is not well served if a firm which has a dominant position in the market is penalised for cutting prices, when that same conduct if undertaken in the same circumstances by a firm which was not dominant would not be. The facts need to be scrutinised with particular care to ensure that this does not happen. Their Lordships have not found it possible to say, despite the obvious care and attention that has been given to them, that this has been achieved in this case. They must stress again the fundamental point of principle on which they base their opinion, that it is not the purpose of section 36 to deny to a person who is in a dominant position in the market the opportunity to protect his market share when his position is threatened by competitors.

It is right to add that their Lordships have derived much assistance from the discussion of this issue by the High Court of Australia in Boral Besser Masonry Ltd v Australian Competition and Consumer Commission (2003) 195 ALR 609. That judgment, which was not available either to the High Court or to the Court of Appeal in this case, re-affirms the importance of the counterfactual test. It contains a particularly strong warning by Gleeson CJ and Callinan J at p 632, para 123, that price-cutting is not a badge of the use of dominance. It also contains a valuable analysis, particularly by McHugh J at p 666-672, paras 274-292, of the importance that the ability to recoup losses by raising prices later without fear of reprisals has in distinguishing between price-cutting that is competitive and that which is anti-competitive. There must, as he indicated at p 668, para 279, be a causal connection between the dominant position and the conduct which is alleged to have breached section 36. That will not be so unless the conduct has given the dominant firm some advantage that it would not have had in the absence of its dominance. It is the ability to recoup losses because its price-cutting has removed competition and allows it to charge supra-competitive prices that harms consumers. Treating recoupment as a fundamental element in determining a claim of predatory pricing provides a simple means of applying the section without affecting the object of protecting consumer interests: p 672, para 292.

Their Lordships are not persuaded that the facts which were found proved in this case show that INZCO's conduct, in the face of strong competition from NWP and in response to the demands of its distributors, was any different from that which a non-dominant firm of equivalent financial strength would have resorted to in the same circumstances. The absence of a rigorous examination of this point is a significant flaw in the High Court's judgment and that of the Court of Appeal. If, as the minority indicate, their findings lead to the conclusion that there was nothing effective that INZCO could have done in the short term and to uncertainty about what could have been one in the long term, they lead to the wrong answer. Moreover, there was no evidence that the "2-for-1" pricing of Wool Line was resorted to by INZCO with a view to charging supra-competitive prices at a later date on that or any other of its products. It was a response to competition in an area of a market which it dominated but where it had nevertheless been shown to be vulnerable. The price level had been set by NWP, and no-one could sell a product comparable to Wool Bloc at a higher price and be competitive. Without the offer of a comparable product to that of its distributors INZCO was at risk of losing its market share, and in the Nelson/Marlborough area it was already doing so.

Measured by the standards described in Boral Besser Masonry Ltd v Australian Competition and Consumer Commission (2003) 195 ALR 609, the evidence about INZCO's conduct shows that from start to finish it was the need to compete in the South Island regional market that was the driving force. This was not conduct in which INZCO was using, and thus abusing, its position of dominance. The case against it under section 36 of the 1986 Act was not made out.

Their Lordships will humbly advise Her Majesty that the appeal should be allowed. The respondent must pay the costs of the appeal to their Lordships' Board and of the proceedings in the courts below.

_________________

Dissenting judgment by Lord Scott of Foscote and

Baroness Hale of Richmond

We regret that we are unable to concur in the opinion of the majority. The appellant INZCO was convicted of a breach of section 36(1) of the Commerce Act 1986. The section prohibits the use of a dominant position in a market.

"(1) No person who has a dominant position in a market shall use that position for the purpose of –

(a) Restricting the entry of any person into that or any other market; or

(b) Preventing or deterring any person from engaging in competitive conduct in that or in any other market; or

(c) Eliminating any person from that or any other market

…"

The issue for the Board on this appeal can be shortly stated. Was there evidence before the High Court that entitled the High Court to find that INZCO had used its dominant position in the South Island building insulation products market for the purpose of preventing or deterring NWP from engaging in competitive conduct in that market or eliminating NWP from that market? Before the High Court and before the Court of Appeal a number of important and difficult issues of fact and of law had to be decided. It is not a matter of surprise that the trial in the High Court took six weeks. But by the time the appeal came to be opened before the Board it had become common ground that (1) INZCO did have a dominant position in the South Island in the building insulation products market, (2) that in December 1993 INZCO placed on the market a wool/polyester insulation product, Wool Line, in order to provide a full range of insulation products to the builders' merchants with whom it had distribution agreements, (3) that in March 1994 INZCO reduced the price at which it sold Wool Line to the merchants to a level 17 to 28 per cent below the cost to INZCO of production and delivery to the merchants, (4) that INZCO maintained the price at that level for some seven months, (5) that the price level at which Wool Line was sold to the merchants was intended to enable the merchants to offer Wool Line to the public at a price more or less the same as that at which NWP's Wool Bloc, also a wool based insulation product, was being offered for sale to the public by NWP and (6) that the underlying purpose of INZCO's pricing policy for Wool Line over the seven month period from March 1994 was to eliminate Wool Bloc as a competitor to INZCO's products in the building insulation materials market in the South Island. The findings of the High Court to this effect were upheld in the Court of Appeal and are no longer challenged.

The only issue remaining outstanding is whether INZCO, in adopting and maintaining its below cost pricing policy for the proscribed purpose described, was using the dominant position in the market that it enjoyed. Williams J and Professor Lattimore in the High Court held that it was. INZCO's appeal against this finding was dismissed by a unanimous Court of Appeal. It is unusual for the Board to entertain an appeal against concurrent findings of fact by the trial court and a unanimous appellate court. The reversal of such findings requires, in our opinion, that the findings be shown to be clearly wrong. It is not, in our respectful opinion, enough for the Board to be "not persuaded" that the findings were correct (see para. 68 of the majority decision).

The question whether INZCO, in adopting and maintaining its Wool Line below cost pricing policy, was using its dominant position requires, as a preliminary, an identification of the factual features that produced the conclusion that INZCO had a dominant position. There are two reasons why this preliminary exercise is necessary. First, a conclusion of "dominant position" is, in the present case and presumably in all cases, based on a number of features of the business being carried on by the market operator in question. It is necessary to be clear about what the features are that have led to the dominant position conclusion before trying to answer the question whether the dominant position has been used. Secondly, the counterfactual test, on which great reliance was placed by Mr Sumption QC, counsel for INZCO, requires it. In the Telecom case [1995] 1 NZLR 385 the Board said at page 403 –

"… it cannot be said that a person in a dominant market position 'uses' that position for the purposes of s.36 unless he acts in a way which a person not in a dominant position but otherwise in the same circumstances would [not] have acted."

(We have added the word "not" to the cited passage since its omission was an obvious mistake. The sentence does not otherwise make sense)

There may in many cases be some uncertainty as to what the "same circumstances" should include or must exclude. But it is clear that they cannot include the circumstances that together constitute the person's dominant market position. The hypothetical comparator must not be a person in a dominant position.

Section 3(8) of the 1986 Act amplifies what is meant by "a dominant position in a market". Section 3(8) says that –

"… a dominant position in a market is one in which a person … is in a position to exercise a dominant influence over the production, acquisition, supply, or price of goods or services in that market."

and then goes on to identify the factors that must be taken into account in determining whether a person is in a position to exercise that dominant influence –

"… regard shall be had to –

(a) The share of the market, the technical knowledge, the access to materials or capital of that person …:

(b) The extent to which that person is constrained by the conduct of competitors or potential competitors in that market:

(c) The extent to which that person is constrained by the conduct of suppliers or acquirers of goods or services in that market"

Williams J, in reaching his decision that INZCO was in a dominant position in the South Island building insulation products market, had regard to these factors. He concluded that INZCO had a 75 to 85 per cent share of the market (para.236) and access to considerable technical expertise (para.237). He noted that INZCO had the requisite access to materials and was "financially very secure" (para.238). As to paragraph (b) of section 3(8), the judge concluded that "INZCO … felt itself largely free of the practical consequences of competition" and that "as far as Pink Batts, Wool Line and its business in general were concerned, INZCO felt itself able to set prices and conditions largely without having its course of action influenced by outside considerations" (para.239).

The combination of the factors to which he referred led Williams J to conclude that INZCO was in a dominant position in the building insulation products market in the South Island. The hypothetical comparator, for the purpose of the counterfactual test, must be an operator in that market who is not in a dominant position but would otherwise be acting in the "same circumstances" as applied to INZCO. So the hypothetical comparator must be a producer of insulation products who sells to builders' merchants but has no distribution agreements comparable to those of INZCO, who is subject to constraints as to pricing imposed by the conduct of competitors and who has no significant market share. In short, the hypothetical comparator is to be taken to be a person carrying on business in a normal competitive market. And, having regard to the reference in section 3(8)(a) to access to capital and to the undoubted strength of INZCO in that respect, it is probably necessary to regard the comparator as having no particular financial strength.

It is, of course, true that a particular market operator may, without itself achieving a dominant position, possess some but not all of the attributes of INZCO that led to the conclusion that INZCO enjoyed a dominant position. It is here that the counterfactual test runs into difficulty. How are the attributes of the hypothetical comparator to be identified? It is all very well to say that the comparator must be "a person not in a dominant position but otherwise in the same circumstances …" as INZCO but it is the circumstances of INZCO and its business that have endowed INZCO with its dominant position. And what is to be the test of what the hypothetical comparator would do? Is the test what a financially prudent operator in the market would do? Or what an entrepreneurially minded operator, who could stand the loss of a few thousand dollars, might do? It must, in our opinion, be kept in mind that the counterfactual test is not a test demanded by statute: it is a judicially constructed tool, fashioned for the purpose of assisting in answering the question to which the statute, i.e. section 36, does demand an answer, namely has there been a use of a dominant position in order to achieve a proscribed purpose.

The problem with trying to apply the counterfactual test in the present case is that the business imperatives that led INZCO to seek, by its below cost pricing policy in respect of Wool Line, to remove NWP and Wool Bloc from the market, make the construction of a hypothetical comparator "not in a dominant position but otherwise in the same circumstances" as INZCO highly unreal. This is a predatory pricing case. But it is not the normal predatory pricing case. In the normal case the dominant market operator lowers his prices to a below cost level in order to drive a competitor out of the market; after which the dominant market operator can raise its prices without the constraint of competition, and hope to recoup the losses incurred in its predatory cut-price campaign (c/f Boral Besser Masonry Ltd. v Australian Competition and Consumer Commission (2003) 195 ALR 609).

This case is not like that. The evidence and the findings have made it clear that INZCO were not concerned about the commercial success of Wool Line as an insulation product. What they were concerned about was the commercial fate of Pink Batts. Pink Batts, a fibreglass insulation product, was the flagship of their insulation product fleet. It had enjoyed a very high market share over a long period and its brand image, INZCO believed, was worth a 10-20 per cent premium over other products (Lattimore para. 27). As the majority opinion has explained, Wool Bloc, a "green" product, was eating into Pink Batts' market share in the Nelson/Marlborough area in the South Island. The builders' merchants, with whom INZCO dealt, wanted a full range of products, including a wool based product, to enable them to compete with Wool Bloc. INZCO wanted to satisfy the merchants' requirements and put a stop to the inroads Wool Bloc was making into Pink Batts' market share.

So the overriding reason why INZCO wanted to see off Wool Bloc was not in order to promote Wool Line, but in order to protect Pink Batts. But Pink Batts, its market share and brand image, was a very significant factor in leading Williams J to his conclusion that INZCO enjoyed a dominant position. How, then, can the counterfactual test be applied? If the circumstances regarding Pink Batts and the agreements between INZCO and the builders' merchants are attributed to the hypothetical comparator, the comparator will be in a dominant position. If these circumstances are not attributed to the hypothetical comparator, the result of the counterfactual test becomes obvious. How could a competitor who was not in a dominant position expect to protect the share of a favoured product in a competitive market by selling another product at a highly uncommercial price? The comparison seems to us, on the facts of the present case, wholly unreal. It seems to us preferable, simply to ask the statutory question. Did INZCO use its dominant position? Was there a causal connection between INZCO's adoption and maintenance of its Wool Line pricing policy and its dominant position based on Pink Batts and its distribution agreements?

It seems to us that economic reality demands the answer "yes" to these questions. The desire to protect Pink Batts and its market share was the reason for the Wool Line pricing decision. Williams J has been criticised in the majority opinion (para.40) for inferring the use by INZCO of its dominant position from the fact of the dominant position plus the fact that INZCO's purpose was a proscribed purpose. But on the facts of this case we do not see how any other inference was possible.

Mr Sumption has submitted that any market operator in INZCO's position would be likely to have taken the same decisions in order to meet the threat of Wool Bloc eating into Pink Batts' market share. We have no difficulty in agreeing with this submission. But a market operator in INZCO's position would have been a market operator in a dominant position. If INZCO had not been in a dominant position, its pricing policy in relation to Pink Batts would have had to be responsive to a competitive market. But the market was not a truly competitive market. At no stage was the price of Pink Batts reduced in order to meet the constraints of competition from Wool Bloc. Instead INZCO adopted its predatory pricing policy for Wool Line. Wool Line was the goat tethered in order to lure the tiger to destruction. Like the goat, the fate of Wool Line was immaterial.

Mr Sumption protested that if the policy adopted by INZCO in order to compete with Wool Bloc were to be regarded as a breach of section 36, INZCO would be prevented from competing. The purpose of section 36 is to promote not prevent competition. What else, he asked, could INZCO have done? The answer may be that there was nothing else effective that in the short term INZCO could have done. They could, of course, have reduced the price of Pink Batts, but it does not appear that that was ever regarded as an option. In the long term they might have developed their own wool based insulation product that could have competed with Wool Bloc on a commercial basis. But in the short term Mr Sumption might well be right. We have to say, however, that our withers are unwrung. The purpose of section 36 is to prevent use of a dominant position for the purpose of stifling competition. Stifling competition from NWP was the very thing that INZCO had in mind. If they had not been in a dominant position, produced by the features of their business to which we have already referred, there might have been price cutting steps in regard to Wool Line that for some period INZCO might have adopted. But INZCO's actual pricing policy regarding Wool Line was a product of their dominant position based on Pink Batts. INZCO was, of course, entitled to compete with Wool Bloc in order to protect the Pink Batts' market share. But it was not entitled to compete by taking steps that relied on its dominant position or that would not have been taken by a non-dominant competitor. If there is a point of principle in this case, this is what it is, and the New Zealand courts, in our opinion, got it right.

The causal connection between INZCO's dominant position and its Wool Line pricing policy seems to us, having regard to primary facts not in dispute, a clear one. This case does not, in our respectful opinion, come within a distance of justifying the Board in setting aside the concurrent findings in the local courts. We would have dismissed this appeal.