CHAPTER 8

FOSTERING COMPETITION AND PROTECTING THE PUBLIC INTEREST DURING THE CONSOLIDATION AND RESTRUCTURING OF THE AIRLINE INDUSTRY IN CANADA

8.1 PURPOSE AND OBJECTIVES

The purpose of this chapter is to deal with the salient aspects relating to competition in the domestic airline industry in Canada, as a result of the deregulation of domestic air transport services and the subsequent consolidation of the industry into an overall dominant airline, Air Canada. In particular the occurrence of predatory practices in the airline industry in Canada, by means of a combination of the provision of too much capacity and lowering of air tariffs, will be examined in order to establish what remedies were adopted by the Canadian government to prevent anti-competitive behaviour in the airline industry and to foster competition.

Specific objectives that will be established are: • To document some of the salient aspects of the development of deregulation in the Canada. • To describe the recent consolidation in the domestic airline industry in Canada that resulted in an overall dominance by Air Canada. • To identify the advice and recommendations of the Commissioner of Competition of the Competition Bureau on restructuring of the airline industry in Canada. • To document the revision of the Canadian domestic air transport policy. • To identify the enforceable undertakings provided by Air Canada to the Commissioner of Competition to enhance competition in a restructured airline industry. • To document the Canadian airline restructuring legislation that includes:

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o The enforcement guidelines on the abuse of dominance in the airline industry, which serves as a code of conduct relating to the practices of anti-competitive acts in the airline industry. o The airline regulations enacted following restructuring of the Canadian airline industry. o The definition of anti-competitive acts by legislation and regulations. o The grant of temporary cease and desist order relating to the abuse of dominance provision by the Competition Tribunal. o The identification of the occurrence of anti-competitive acts in the airline industry by means of the Avoidable Cost Test (as compared with the average variable cost test). • To identify the commercial conduct of Air Canada following the extensive review of legislation and regulations pertaining to competition in the Canadian air transport market in relation to new entrants and smaller airlines. • To assess the actual working of the regulatory steps that were adopted in Canada with regard to complaints raised by new entrants and smaller airlines against the conduct of Air Canada. This would include complaints of a competitive nature by such airlines. • To assess the evaluation of the regulatory steps adopted in Canada with regard to the promotion of competition in the air transport industry in Canada in the future. • To consider some advice and institutional arrangements of the Competition Authorities in Canada.

8.2 DEVELOPMENTS IMMEDIATELY PRECEEDING AIRLINE CONSOLIDATION AND RESTRUCTURING

8.2.1 CANADIAN GOVERNMENT POLICY

Since 1988, with the deregulation of the domestic airline industry, there has been a steady tendency to liberalise both domestic and international services. Initiatives included: • Deregulation of domestic prices and routes. • Liberalisation of international carriage, including "Open Skies" with the USA.

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• Privatisation of air traffic control to Navigation Canada. • Transfer of airports to the private sector. • Liberalisation of international charter regulations for cargo and passenger services. Liberalisation led to profound changes in what the Canadian government can and cannot do. Since the government did not control domestic routes or prices, it could not use air services as a tool of economic or social policy.

However, there are a number of areas where the government remained very much involved. These include: • Areas of safety. • Negotiating the rules around international carriage, which is governed by Canadian policy within a complex set of agreements between nations, and • Regulation of the framework in which CRSs operates.

Recent developments pertaining to air transport regulation in Canada were initiated by a financial crisis at two of the largest Canadian airlines, which resulted in the domestic market being clearly dominated by a single Canadian carrier.

This chapter summarises the developments in the structure of the Canadian airline industry, which paved the way for government intervention. The Canadian government made a number of choices relating to air transport policy. From the interim report of the Independent Transition Observer on Airline Restructuring in February 2001 1) and that of the Commissioner of Competition of the CCB in May 2001 relating to the then current state of airline operations in Canada, it would appear thatthe failure and subsequent acquisition of Canadian Airlines by Air Canada dramatically reduced the level of competition in domestic airline markets despite numerous actions taken by the Canadian government to create the opportunity for entry to the market. 2) The inability of new entrants to profitably enter the air transport market suggested that while entry into the scheduled domestic market may be possible, there are serious doubts about the ability of such firms to remain as sustainable competitors in the face of Air Canada's dominance. The Commissioner of Competition was of the opinion that the need for significant legislative and regulatory changes to promote competition in the airline industry remained strong. 3)

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Canada is in aviation terms Canada is geographically located between the USA and UK and Europe and as a result subject to developments in those countries. As stated, there appears to be a major focus on Canadian control and ownership over Canadian domestic airlines. At the time of writing, such national control and ownership was mirrored in the USA whereas in Europe inter-European ownership and establishment rules have been relaxed substantially. South Africa originally based the Air Services Act of 1949 on the Canadian Air Services Act. 4) 5) and the competition legislation in South Africa has drawn on Canadian competition legislation. 6) The latter was recently substantially altered to cater for the specific needs of the Canadian domestic air transport industry. 7)

8.2.2 INTRODUCTION TO THE CANADIAN DOMESTIC AIRLINE INDUSTRY

Canada's domestic airline industry evolved from being a Canadian government-owned monopoly to a virtually deregulated industry where the market is open to any carrier that can obtain an operating licence and pass a financial fitness test. This environment came about in response to pressure from carriers for less government regulations to allow them to compete in the domestic marketplace. The Canadian government passed the National Transportation Act in 1987, which brought about the economic deregulation of Canada's domestic airline industry.

Since deregulation of air transport services in Canada, there has been a consolidation of the airline industry as a result of a series of mergers and acquisitions. Canadian Airlines International Ltd (CAIL) evolved through the merging of Canadian Pacific (CP Air) with Eastern Provincial Airways, Nordair, Quebecair and Pacific Western Airlines in 1986, and the purchase of Wardair in 1989.

Air Canada consolidated its position by becoming a privatised corporation in 1988, which enabled it to compete without the constraints of being a Crown corporation, including the need for government approval of corporate and financial plans. It also acquired regional airlines, which strengthened its position further.

What eventually emerged from this process was a duopoly controlling 75-85 percent of domestic airline traffic. Both Air Canada and CAIL allied themselves with international Chapter 8 Page 851 alliances - Air Canada as part of Star and CAIL as part of Oneworld. According to the SCOT of Canada, alliances between international airlines acts as a major competitive force in global aviation, providing greater efficiencies of scope, and better service. The SCOT concluded that alliances enabled air carriers to benefit from increased traffic, increased revenues and decreased costs. In particular, membership of global alliances improved the productivity of flight assets through code-sharing, interlining and brand recognition, and enhanced the return on non-flight assets through other sharing activities, usually involving co-locating to share gates, baggage handling, ground handling equipment, ticketing offices and corporate sales forces. Carriers retained their identity, national character and marketing presence while also receiving foreign market presence at relatively low cost.

While the airlines were free to compete, the SCOT heard that it was the view of many witnesses that this duopoly led to destructive competition - competition that has proved to be unhealthy for both carriers and consumers. Instead of the two carriers reaching a stable competitive equilibrium, they chose instead to compete head-to-head even when there was insufficient traffic for two carriers (as a result of excess capacity overall in comparison with demand). The result was that in 1998 CAIL was in serious financial difficulty and Air Canada did not achieve the profitability or share value that might have been attained had they engaged in less destructive competitive behaviour.

In the summer of 1998, CAIL stated that it was in critical financial shape and would not have the necessary fiscal resources to "go it alone" for much longer. Recognising its financial difficulties, early in 1999 CAIL approached Air Canada to discuss the possibility of a "friendly merger." While they agreed in principle on many of the proposed terms, discussions were not successful.

With CAIL continuing to face financial problems, on 13 August 1999 the Governor in Council issued an order pursuant to section 47 of the Canada Transportation Act (CTA), which altered the normal process in order to allow proposals for restructuring to come forward. This extraordinary action led to a re-examination of Canada's airline industry in view of the job losses, increased fares, diminished shareholder value and bailouts that have characterised either or both of the national carriers since deregulation. 8)

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A chronological summary of the major events relating to the bidding war between Air Canada and Onex for control over the combined resources of Air Canada and CAIL is set out in annexure “AC”.

8.3 CONSOLIDATION IN THE DOMESTIC AIRLINE INDUSTRY IN CANADA

A major revision in the air transport policy in Canada became necessary as a result of consolidation in the domestic airline industry, which resulted in an overall dominance in the airline industry in Canada for Air Canada.

According to the assessment of Johnson T, of CBS News Online, both CAIL and Air Canada entered the 1990s with a sense of optimism about the first full decade of unregulated air travel. 9)

Air Canada was in a much better position to sustain losses from 1991 to 1992 owing to the fact that it carried less debt and proposed to merge CAIL and Air Canada in 1991 and 1992. It also made an offer to buy CAILs international routes. CAIL rejected all Air Canada's offers of Air Canada, and approached AMR Corporation, the parent of AA, for a cash infusion. 10)

Air Canada immediately began to lobby the Canadian federal government to disallow AMR access to the CAIL market. The government effectively did that in the summer of 1992. CAIL had tentatively cut a deal to sell three Airbus 310 aircraft to the Department of Defence for C$150 million, cash that CAIL needed badly. According to Johnson T, the clerk of the Privy Council told CAIL that if it wanted to sell the aircraft, it had better break off talks with AMR. CAIL did so, and soon announced it had re-entered merger talks with Air Canada. 11)

Air Canada made a final merger offer which CAIL accepted. Shareholders and the financial community were not entirely impressed and referred to the proposed merged airline as "Mapleflot". After thinking things through Air Canada's board also had reservations owing to the difficulties of managing the combined debt load of C$7.7 billion, and according to Johnson T, figured that if it waited CAIL would go under and Air Canada would be able to

Chapter 8 Page 853 obtain routes of CAIL's routes for nothing. The merger proposal died and CAIL approached AMR for a cash infusion. 12)

The Gemini reservation system, which Air Canada and CAIL shared, became an impediment as CAIL was required to use the reservation system of AA in order to obtain funding from AMR. Air Canada had no intention of releasing CAIL from its Gemini obligation. It took nearly two years of legal wrangling before CAIL finally obtained a C$246 million cash injection from AMR. In the meantime, CAIL stayed afloat with the help of cash infusions from the Alberta and British Columbia provinces of Canada. The employees of CAIL agreed to wage rollbacks and took shares in the company in lieu of wage increases. Together with the AMR cash injection, employees agreed to invest C$200 million in CAIL and creditors agreed to swap C$700 million in debt for shares in the airline. CAIL ended its 1994 financial year with a vastly improved balance sheet, but it was still unprofitable. 13)

When the airline did not return to profitability in 1995 another restructuring plan was launched in 1996 that demanded that the employees take a 10 percent pay cut. This was agreed to by all the unions and a year later CAIL posted a second quarter profit of C$2.6 million. That was the end of positive earnings. During 1998 the “Asian economic flu” caused a drastic decrease in air travel in the Pacific Rim, which was Canadian's most lucrative market. While at home, Air Canada launched seat sale after seat sale, trying to press its financial advantage over CAIL. 14) By the end of the year CAIL reported a loss of C$137 million. At its annual meeting in June 1999, CAIL surprised shareholders and media by suggesting Air Canada and CAIL collaborate on sharing underused routes. Industry observers were of the opinion that CAIL was finally raising the white flag in its 62-year battle with Air Canada. Six weeks later the government suspended a section of the Competition Act to allow the airlines to discuss restructuring the industry. All signs pointed to a single national carrier in Canada. 15)

A proposal by the Onex Corporation was a surprise to observers of Canada's airline industry. In late August 1999, Onex Corporation offered to buy and merge Air Canada and CAIL for C$5.7 billion. Many regarded it as a much-needed boost to the industry, but others greeted it with scepticism and concern. 16)

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Schwartz G, the chairman and chief executive officer of the Onex Corporation stated that "as the government has acknowledged, the status quo is clearly not sustainable”. 17) In his view, the financial performance of Air Canada was “far below investor expectations and industry standards when compared to other North American carriers." 18) He noted that since 1990, Canada’s two major carriers lost a total of nearly C$2.0 billion. 19)

He stated that the plan “recognised what has been illustrated by the experience of the past ten years: an air transportation system built around two large domestic network carriers is not sustainable in Canada. In fact, many of the world’s leading industrialised countries has only one leading domestic network carrier. In recognising this reality, our proposal offers an opportunity to reshape and revitalise this all-important industry and to assure that Canada has a world-class Canadian-owned air transportation system as it enters the 21st century”. 20)

The plan included a proposal that the resulting new Air Canada would have a comprehensive alliance with AA, in order to “further enhance the new airline’s competitive position and its international service”. 21) The alliance would include reciprocal FFPs and code-sharing agreements. In addition, the new Air Canada would become a member of Oneworld, a global alliance of world-leading airlines including AA, BA, Cathay Pacific, Qantas Airways and, when they join in the next several months, Iberia, Finnair and Lan Chile. 22)

Clayton I and Wiese A, stated that the proposal sparked a bidding war with Air Canada that saw Onex's original share bid of C$8.25 per share for Air Canada eventually rise to C$17.50 per share. Finally, a Quebec court judge ruled that the proposal was illegal and derailed the Onex proposal. 23)

Onex and its partners initially offered C$5.7 billion to buy and merge Air Canada and CAIL - C$1.8 billion in equity, C$3.9 billion in assumed debt. The proposal would have resulted in the following major shareholdings of the merged business: • Onex, 31 percent. • AA, 14,9 percent. • Public shareholders, 54 percent. 24)

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The interest of AA of 14,9 percent was however larger than the then 10 percent statutory limitation of single shareholding in Air Canada. Air Canada regarded the Onex bid as a hostile takeover, and adopted a shareholder rights plan with a "poison pill" which increased the amount of outstanding shares, effectively doubling the price of any takeover bid that did not have the approval of Air Canada's board. 25)

The board of directors of Air Canada also called a special meeting of Air Canada shareholders for 7 January 2000 to consider proposals, including the offer from Onex. That was two months beyond the 11 November 1999 deadline set by the Canadian government in Ottawa, when competition rules were set to go back into effect. 26)

Onex obtained a court ruling forcing Air Canada to hold the meeting on 8 November 1999. There was also widespread concern that if the merger went ahead, Americans would control Canada’s one major airline as AA would be given the right to control the carrier's scheduling, ticket prices and the FFP, for instance. 27)

But Schwartz rejected the suggestion of creeping foreign control, pointing out that American would only have two seats on the merged airline's board of directors. Schwartz also said Onex would make undertakings to Ottawa that the new Air Canada would remain under domestic control. 28)

The deal was structured so that public shareholders would always own at least 50 percent of the new Air Canada, and Canadians would start off owning 85 percent of the new airline. AMR agreed that its equity investment in the new Air Canada would not exceed 14,9 percent and had publicly stated its intention to reduce its shareholdings as soon as reasonably possible. AMR would also not convert its Air Canada debentures and warrants into equity if that conversion would cause its equity interest to exceed 14,9 percent. 29)

Air Canada raised its offer to C$16 a share following which Onex increased its offer to C$17.50 a share (on 5 November 1999, three days before the shareholders’ meeting). 30)

A Quebec Superior Court judge ruled that the hostile takeover bid of Air Canada was illegal in terms of the existing legislation, as according to Mr Justice Wery A, the Onex proposal

Chapter 8 Page 856 would violate the law that limited ownership in Air Canada by a single shareholder to 10 percent. 31)

Air Canada was delighted and pressed forward with its bid to take over Canadian. Milton of Air Canada stated that “… we are willing to fix the situation by taking CAIL under our wing ... and making that airline achieve what it is capable of achieving”. 32)

Federal Transport Minister David Collenette said Canadian would be protected under any airline restructuring. In November 1999, after Onex was out of the running, Collenette said he was sure a solution could still be found with the remaining Air Canada bid. “On the assumption that (Air Canada's offer to buy Canadian) proceeds, then obviously the Canadian government and parliament have to make sure that the public interest is maintained in any restructuring”. 33)

The Federal Competition Bureau spent months reviewing the takeover. Collenette, the Federal Transport Minister, was expected to table new legislation governing the operation of the industry by February 2000. Air Canada stated that it was willing to have its bid come under any scrutiny from the Competition Bureau and the DOT. 34)

Air Canada's Chief Executive Officer, Milton R, was pleased to have his bid finally accepted by the CAIL board. On 5 December 1999 he called the move an “encouraging development” and regarded it as good news for employees and shareholders of CAIL. He also held the view that the deal should make Canadian's customers more confident about the future. 35) As a result, in December 1999, Air Canada became dominant in the Canadian air transport market. This was, however, subject to the airline's giving undertakings to foster competition in the Canadian airline industry as set out in this chapter.

8.4 INTRODUCTION TO GOVERNMENT INVOLVEMENT IN RESTRUCTURING OF AIR TRANSPORT IN CANADA

On 13 August 1999, an order-in-council was signed by the Governor in Council (made by the Ministers of Transport and of Industry) in terms of authority contained in section 47 under the extraordinary disruptions section of the CTA for a 90-day period in order to permit two Chapter 8 Page 857 large airlines (CAIL and Air Canada) and other interested parties (Onex Corporation) to discuss and elaborate various arrangements, including possible airline mergers, without risk of contravening the competition law. 36) 37)

The government of Canada took this action because of concern relating to the potential for disruption to the national transportation system that might have resulted from the “weak financial position of CAIL and because it wanted to ensure that all aspects of the public interest were considered in any major restructuring of the airline industry”. 38)

The Minister of Transport was of the opinion that a major restructuring of the airline industry in Canada could either lead to a single large air carrier being created through a merger, acquisition or other means, such as a business failure, or alternatively, the two major carriers could come under common ownership. Under either scenario, one entity or the commonly controlled entities would offer most of the services and carry the majority of passengers. The same carrier or carriers would also offer the great majority of Canada-USA and other international services provided by the Canadian airline industry. 39)

The Minister of Transportation had indicated that if a conditional merger agreement were proposed within the 90-day period, he would determine if it served the public interest or whether conditions should be set in order to protect the public interest. The Minister said he would evaluate any proposed agreement after making a balanced evaluation of transportation interests and from the perspective of competition policy, in order to: • Assure the long-term viability of the air transport industry, and • Conserve the advantage competition brings to consumers. 40)

The Minister of Transportation also indicated that the Competition Bureau would be consulted on how to achieve a pro-competitive outcome as soon as possible and that its views would be taken into consideration prior to any decision being taken. 41)

On 24 August 1999 the Onex Corporation announced its intention to acquire both Air Canada and CAIL. The plan was conditional on, inter alia, there being no merger review by the Competition Bureau. A shareholder vote was scheduled on 8 November, just prior to the expiry of the suspension order. 42)

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Air Canada initiated legal proceedings in an effort to have the order-in-council declared illegal. This included questions raised as to the effect of the order and whether it would rule out review under the competition law of any proposed merger of the two airlines. 43)

On 30 August 1999 Collenette DM, Minister of Transport of Canada, called for opinions on competition issues as a result of a potential restructuring of the Canadian airline industry on the basis that: • A dominant carrier will emerge from the process. • The current framework for Canadian ownership and control will not change, and • Foreign carriers will not be allowed to fly domestic routes. 44)

The Minister of Transport requested the Commissioner of Competition to advise him with on government action or conditions to mitigate competition concerns arising from a restructuring of the industry. 45)

On 14 October 1999, the order-in-council order was referred to the SCOT and Communications for review. On 26 October 1999 the Minister of Transport, Collenette DM, appeared before the committee and gave the background to the order in council. The Minister of Transport requested the Committee to give him advice on a number of matters related to airline policy. He indicated the willingness of the government to take steps in a number of areas, but confirmed that there would not be any change in the Canadian ownership and control requirements. 46)

Two documents were submitted to the Standing Senate Committee on Transport, namely a Transport Canada document entitled "A Policy Framework for Airline Restructuring in Canada, October 1999" and the other was a letter dated 22 October 1999 to the Minister of Transport from the Commissioner of the Competition Bureau which was a response to a request from the Minister of Transport for the views of the Competition Bureau on competition issues that would arise as a result of the potential airline restructuring. 47)

The Minister of Transport informed the Committee that there were three options for dealing with the problem:

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• To help CAIL financially. • To allow the bankruptcy of CAIL, and • To restructure the industry in some way. 48)

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8.5 OVERVIEW OF GOVERNMENT POLICY RELATING TO AIRLINE RESTRUCTURING IN CANADA

After the Canadian Minister of Transport became aware that a radical restructuring of the airline industry was unavoidable in August 1999, the government of Canada began a series of steps designed to protect the Canadian public interest in the following ways: • By providing an open environment for the unfettered discussion of restructuring options. • A policy framework (with major input from the Commissioner of Competition) to guide stakeholders was developed and presented. • Advice was sought from the members of the Canadian Parliament. Extensive hearings were held with stakeholders, and both the House of Commons and the Senate standing committees provided recommendations to the Canadian government. • The Minister of Transport negotiated specific commitments with Air Canada related to maintaining service to communities and the protection of jobs, after which the Commissioner of Competition negotiated a series of undertakings designed to foster competition. • On 21 December 1999 the Canadian government approved Air Canada’s acquisition of CAIL subject to the undertakings designed to foster competition. • A Bill C-26 was introduced into the House of Commons, which included changes to the CTA, the Competition Act and the Air Canada legislation. Legislation came into force on 5 July 2000 which: o Made the commitments and undertakings made by Air Canada enforceable. o Provided new powers to the Competition Bureau in order to address anti- competitive behaviour, and o Provided powers to the Canadian Transportation Agency (CTA) to monitor prices on monopoly routes and to address a wider range of consumer complaints. 49)

The following institutional arrangements were made to ensure that Canadian travellers continue to be protected by vigilant oversight through action to increase protection for consumers and communities and action to foster competition:

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• The Competition Bureau was granted new powers to address anti-competitive behaviour within the airline industry. • A Vice-Chairman of the CTA with special responsibilities in the area of air travel complaints was appointed. • An Air Travel Complaints Commissioner (who would also be a Member of the CTA) was appointed at the CTA to review complaints, to ensure that all alternative solutions have been exhausted and, where appropriate, to mediate an outcome that satisfies both the consumer and the airline. The objective was that there needed to be someone in the federal machinery of government to act as the champion of consumers who are dissatisfied with their treatment by airline companies. The Commissioner would report to Parliament through the office of the Minister of Transport twice a year, listing the complaints received and the carriers involved, and highlighting any systemic problems detected. 50) • An Independent Transition Observer on Airline Restructuring was appointed to provide the Minister of Transport with an independent perspective on what was happening in the air services sector over the following 18 to 24 months. This was necessitated by a general expectation that the airline industry would be in a state of transition for up to two years while consolidation of the two major carriers was being completed. It was also in line with a parliamentary recommendation that government keep a close eye on the development of other carriers to establish new competition with Air Canada in the light of the possible impact of airline restructuring as well as the request by the SCOT for a review within two years of the impact of restructuring on the airline industry. The Canadian government agreed that the situation relating to the overall impact of airline restructuring on “consumers, urban, rural and remote communities, travel agents, airports, and airlines and their employees should be monitored in order to know how the industry is performing if we are to make improvements as regulators”. 51) Transport Canada would perform the monitoring function and will observe developments as well as develop alternative reporting mechanisms for Canadian carriers, such as those used in the USA and investigate the need for an air travellers’ bill of rights. 52) 53)

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8.6 REPORTS THAT RESULTED IN A NEW CANADIAN GOVERNMENT POLICY TO FOSTER COMPETITION

A listing of reports that were instrumental in the development of a new Canadian government policy to foster competition in the Canadian airline industry is provided as annexure "AD". These reports were produced during the reviewing of Canadian Air Transport Policy in the process of the emergence of a single dominant airline. The reports analysed the economic and legal implications of certain salient aspects of air transport policy in Canada and contained certain recommendations and guided governmental intervention with the object of developing competition within the Canadian airline industry.

The analysis of the developments begins with the advice and recommendations of the Commissioner of Competition to the Minister of Transport, which indicates the advisory role of the Commissioner of Competition. Following receipt of such advice from the Competition Bureau, the Minister of Transport published a proposed policy document entitled, “A Policy Framework for Airline Restructuring in Canada”. This illustrates the level of importance of the advice of the Commissioner of Competition to the Canadian government. The Standing Committee on SCOT and the Senate Committee on Transport and Communications issued two reports entitled Restructuring Canada’s Airline Industry: Fostering Competition and Protecting the Public Interest - First Report as well as a second report, Airline Industry Restructuring in Canada respectively after wide consultation in the process of development of the government policy relating to airline restructuring in Canada. The reports analysed the economic and legal implications of certain salient aspects of air transport policy in Canada and contained certain recommendations pertaining to the development of the restructuring of Canadian air transport policy.

The economic and legal analysis of the topics/issues raised in these four reports as well as the recommendations of the Minister of Transport, the Commissioner of Competition, the SCOT and the Senate Committee on Transport and Communications are compared and discussed in 8.10, where the major considerations and recommendations on the various issues are summarised. In this analysis, the relevant enforceable commitments and undertakings made by Air Canada to the Minister of Transport and the Commissioner of Competition as well as the response of the Canadian government to the two Reports of Standing Committees on

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Transport are noted. This analysis enables the reader to consider the various views of such parties as well as the final government decision for intervention on each topic/issue.

Further action by the Canadian government in terms of legislation and regulations and the very important step of defining what constitutes unacceptable airline practices and institutional arrangements for monitoring the situation followed the abovementioned process and are discussed in section 8.11 of this chapter. Finally, certain developments in the domestic airline market, following the adoption of a new governmental policy, will be considered in separate sections.

8.7 ADVICE AND RECOMMENDATIONS OF THE COMMISSIONER OF COMPETITION ON THE RESTRUCTURING OF THE AIRLINE INDUSTRY IN CANADA

8.7.1 INTRODUCTION TO THE ROLE OF THE COMPETITION BUREAU IN THE RESTRUCTURING OF THE AIRLINE INDUSTRY IN CANADA

8.7.1.1 Request for Advice

On 30 August 1999 Collenette DM, Minister of Transport of Canada requested views on competition issues as a result of a potential restructuring of the Canadian airline industry on the basis that: • A dominant carrier will emerge from the process. • The current framework for Canadian ownership and control will not change, and • Foreign carriers will not be allowed to fly domestic routes. 54)

8.7.1.2 Mandate for Response of the Competition Bureau

The Competition Bureau did not examine any specific restructuring proposals and the Minister of Transport specifically directed the Competition Bureau not to look at the government policies of foreign ownership and cabotage and the carrier designation under

Chapter 8 Page 864 open skies. The Minister of Transport requested the Competition Bureau to advise him on how the outcome of the restructuring of the airline industry could be as pro-competitive as possible. 55)

In his response on 22 October 1999, the Commissioner of Competition stated that the Competition Bureau would like to ensure that all Canadians enjoy the benefits of a competitive marketplace - low prices, product choice and quality service, but that his terms of his reference excluded an examination of the government's policies on foreign ownership and cabotage - that is, allowing foreign airlines to fly domestic routes, which policies were seen as “the largest regulatory barriers to entry into the airline industry”. 56) The advice of the Commissioner of Competition was, as a result, limited to: • Identification of the competition issues as the Competition Bureau saw them, and • Indications of any conditions or government actions that the Competition Bureau feels might mitigate them. 57)

8.7.1.3 Conditions to remedy the substantial lessening of competition

As in a typical merger review, where the Competition Bureau would find that the merger would lead to a substantial lessening of competition, certain conditions to remedy the substantial lessening of competition would be imposed by the Competition Bureau, which the merging companies must satisfy in order to move forward incurring opposition from of the Competition Bureau. The objective of such conditions generally is to facilitate the entry into the market of new competitors or to allow existing companies to expand and provide real competition. 58)

The Competition Bureau outlined some of the conditions that might have to be imposed in an airline restructuring in its letter to the Minister of Transport. These included: • Surrendering arrival and departure times (known as slots). • Returning airport facilities to the appropriate authority for reallocation. • Change the way airlines pay for airport services. • Ensure that any new airline competitors be able to purchase the dominant carrier's frequent flyer points.

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• Change the method of calculating travel agents' commission (not to base TACOs on market share in the domestic market). • Offer to transfer surplus planes to any new entrants. • The possible divestiture of regional carriers, and • Ensuring that new or expanding airlines were able to interline and code share with the dominant carrier. 59)

In addition, the establishment of more effective ways of fighting predatory behaviour by the dominant carrier were recommended, as the Competition Bureau was of the opinion that predation can constitute a major barrier to entry. 60)

Although the Competition Bureau focused its analysis on the emergence of a dominant carrier, it was of the opinion that many of its recommendations could be implemented in a non-dominant carrier environment for the benefit of all Canadians. 61)

8.7.1.4 Alternatives to allow new competitors to create real choices for passengers and impose a price discipline on the dominant carrier

Von Finckenstein K, was of the opinion that the recommended conditions that could be required in connection with the approval of a restructured airline would not be sufficient and urged the Canadian government to consider implementing the key recommendations of governmental policy changes which would allow new competitors to create real choices for the flying public and impose a price discipline on the dominant carrier. These were: • Allowing a modified 6th freedom which would allow US carriers to pick up passengers in one Canadian city and fly to another Canadian city via the USA. • Allowing the creation of the concept of Canada-only carriers, which carriers would be free of any foreign ownership and control restrictions but would only operate domestic air services, and • Raising the foreign ownership limit of airlines from 25 percent to 49 percent. 62)

These recommendations were proposed as the Competition Bureau was of the opinion that there was no assurance that the then existing charter carrier and regional carriers were likely to expand to provide sufficient competition to a dominant carrier that would carry more than

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80 percent of the domestic passengers and account for close to 90 percent of the domestic revenues. 63)

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8.7.1.5 Merger review by the Competition Bureau

At the expiry of the 90-day suspension period of the order-in-council made by the Ministers of Transport and of Industry in terms of authority contained in the CTA in November 1999, the Competition Bureau was notified of a proposed acquisition of CAIL by Air Canada. This prompted a two-stage review of the acquisition under the merger provisions of the Canadian Competition Act. 64)

The Competition Bureau initially confirmed that CAIL was facing imminent financial failure. Following that conclusion, the Competition Bureau considered certain commitments that Air Canada was prepared to make if the merger was allowed to proceed.

These were: • To surrender slots at Pearson Airport. • To surrender gates, loading bridges and counters at a number of airports across Canada. • To delay launching a discount carrier in Eastern Canada to give other Canadian carriers the opportunity to become established. • To offer Canadian Regional Airlines for sale. • To allow other Canadian carriers to participate in its Aeroplan programme to base its domestic TACOs on volume rather than market share. • To enter into interline and joint fare agreements with other Canadian air carriers. 65)

The Competition Bureau concluded that the merger, together with such commitments, was preferable to the bankruptcy and liquidation of CAIL. Consequently the Competition Bureau informed Air Canada that it would not oppose its acquisition of Canadian on December 21, 1999. The Minister of Transport subsequently approved the merger, noting that the government would introduce new legislation governing the airline industry, including amendments to the Competition Act to allow for greater substantive and injunctive powers against anti-competitive conduct. The Bill was introduced in Parliament on 17 February 2000. 66)

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8.7.2 COMPETITION CONCERNS ABOUT THE DOMESTIC AIRLINE PASSENGER MARKET RELATING TO THE EMERGENCE OF A DOMINANT CARRIER

The Commissioner of Competition of the Competition Bureau, Von Finckenstein K, reported to Collenette DM, Minister of Transport that very significant competition concerns will develop in most domestic airline passenger markets if a dominant carrier emerges from the process under the terms outlined in the letter of the Minister of Transport of 30 August 1999. The most vulnerable consumers were seen to be business travellers in transcontinental, regional and local markets, and leisure passengers in local and regional markets. Competition concerns were also foreseen in the Canada–US market (known as transborder markets) and in other international markets.

The Competition Bureau examined many areas that may create more favourable conditions for entry to the market for new players or expansion by existing competitors. None of the generic recommendations made by the Competition Bureau could guarantee that there will be new entry or effective competition. 67)

The historical and current competition concerns that arise from a dominant carrier scenario are summarised in 8.7.2.2 (irrespective of whether it would arise from the merger of Air Canada and Canadian or from the failure of Canadian). In addition, a number of recommendations to mitigate those concerns were presented in four categories: • Terms of restructuring. • Changes in government policy. • Regulatory changes, and • Legislative changes. 68)

The Competition Bureau concluded that even in high-density markets where entry is most likely to occur, travellers were unlikely to enjoy competition with respect to: • Frequency of service. • Range of service, and • Frequent flyer points.

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The Competition Tribunal based its concern on several factors including: • The overwhelming dominance of the remaining national carrier. • The difficulty of successful entry, the lack of effective remaining competition, and • The prohibition of foreign competition in domestic markets. 69)

The Competition Tribunal also noted that Air Canada and Canadian compete across the full range of product characteristics, including: • Frequency of service. • Choice of seat classes. • FFPs. • Distribution through CRSs, and • Price. 70)

The Competition Tribunal identified a number of barriers that make large-scale successful entry difficult, including: • Feed traffic at both ends of an origin-destination route that are important to providing service over a network of scheduled flights. It adds to profitability and allows for more frequent service. • FFPs and commission structures (several incentives were identified): o A widely accepted FFP is necessary to attract business travellers. o Without a large volume of business, new entrants would have to pay higher commissions to agents than would a dominant carrier. o It was industry practice to pay additional commissions (overrides) to loyal travel agents. It was found that these commission overrides could have an exclusionary effect when used by a dominant carrier. 71)

While the Competition Tribunal acknowledged that agreements and alliances among individual carriers might mitigate some of the barriers to entry, it found that (when the effect of all the barriers in combination is considered and given the absence of available carriers with which individual airlines could form alliances) piecemeal entry by individual airlines would leave such new entrants at a significant disadvantage. 72)

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The Competition Tribunal noted that the disappearance of Canadian would have left most city-pairs that at that time were served by Canadian and its affiliates with monopoly service from Air Canada. Even in those markets where entry or expansion could be anticipated, there was no evidence that it would be of a degree or kind that could be considered a reasonable replacement for CAIL from a competition point of view.

The Competition Tribunal also noted agreement among expert witnesses on the issue of cabotage that stated that if foreign airlines were allowed to serve the Canadian domestic market, competition on high-density domestic routes would not be a problem if Canadian failed. The Competition Tribunal did, however, acknowledge that the Canadian government did not permit cabotage and there was no evidence to indicate that it would be allowed in the foreseeable future. 73)

The Competition Bureau concluded that if a dominant carrier emerges that would provide most of the international services out of Canada, competition concerns may arise in certain international and transborder markets. These concerns would be magnified when the dominant carrier joins an alliance whose partners fly the same international routes. 74)

The objective of the recommendations of the Competition Bureau was to mitigate competition concerns by reducing entry barriers, facilitating new entry and expansion by remaining competitors and restricting the ability of the dominant carrier to engage in anti- competitive acts. It was of the view that, given the market power of the dominant carrier that will result from the restructuring process, it is vital that every opportunity be taken to promote and create competition. The Competition Bureau also stated that most of the recommendations could also be implemented in a non-dominant carrier environment for the benefit of Canadian consumers. 75)

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8.8 REVISION OF THE CANADIAN DOMESTIC AIR TRANSPORT POLICY

8.8 1 INTRODUCTION

This section represents a summary of the economic and legal analysis, recommendations and government action with regard to the salient competition related aspects associated with the airline industry in Canada, that were contained in the principal reports: • A Policy Framework for Airline Restructuring in Canada - Minister of Transport, October 1999. 76) • Advice and Recommendations of the Competition Bureau relating to terms and conditions that could be imposed on the dominant carrier, 22 October 1999. 77) • Restructuring Canada’s Airline Industry: Fostering Competition and Protecting the Public Interest - First Report of the SCOT - 8 December 1999. 78) • Airline Industry Restructuring in Canada - Senate Committee on Transport and Communications Second Report, December 1999. 79)

A summary of the salient aspects of the economic and legal analysis, recommendations and governmental action that resulted pertaining to various issues of the Minister of Transport, the Commissioner of Competition, the SCOT and the Senate Committee on Transport and Communications that resulted in enforceable commitments and undertakings made by Air Canada to the Minister of Transport and the Commissioner of Competition is presented in this section. These were in turn followed by a legislative response by the Canadian government and enforcement guidelines that were issued by the Commissioner of Competition, which are discussed later in this chapter.

8.8.2 CANADIAN OWNERSHIP AND CONTROL

The Minister of Transport stated that Canada’s airline industry would “remain controlled by Canadians”. The airline industry was seen to be: o Fundamental to the Canadian economy. o An important national symbol.

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The Minister of Transport also stated that “most countries retain national ownership requirements for their airlines and do not allow foreign carriers to serve their domestic markets”. 80) Whilst this is the case in the USA, this is not the case in Australia where fully foreign owned airlines may operate domestic air services (refer to 8.8.9.1, 8.8.9.2, 8.8.9.2, 8.22.6, 8.22.8 and 8.25.3.2 below) and in the EU national ownership has been replaced by another concept, that of the EU community ownership (requiring majority ownership and controlled by European nationals), allowing any European airline access to inter European routes. 81)

The CTA limits non-Canadians to owning a maximum total of 25 percent of the voting shares of any Canadian airline (although the Governor-in-Council can raise this limit). The CTA also requires that control "in fact" must remain with Canadians. The Air Canada Public Participation Act repeats the limitation on foreign ownership for Air Canada. 82)

The SCOT was of the opinion that for many Canadians ownership and control of the carriers within Canada's airline industry was the most contentious issue and critically important. As the airline industry was seen as a vital contributor to economic growth and prosperity, and the social fabric of Canada owing to its geography and population distribution. In determining where control "in fact" lies, the CTA analyses financial, managerial and operational relationships. 83) In this regard, the Senate Committee on Transport and Communications was concerned that there were ways around the restriction as financially a foreign airline may not be a controlling owner, but could well function as an influential banker. In its assessment, raising the 25 percent limit in general would exacerbate the concerns regarding influence. 84)

Another factor that demonstrates the concern relating to ownership in Canada was that the Investment Canada Act was also relevant, as it applied when a single foreign investor wished to acquire more than 33⅓ percent of any Canadian enterprise. This Act permits foreign shareholdings in a Canadian company up to 50 percent less a share, provided that these shares are widely held and that management control remains with Canadian shareholders. As a result, unlike most other countries where ownership and control requirements are a specific feature relating to civil aviation regulation, Canada has a general concern relating to ownership and control of enterprises, probably due to its closeness to the USA. This differs quite considerably from the situation in South Africa where in terms of the White Paper on Chapter 8 Page 873

RDP of 15 November 1994 it was stated that the South African "government welcomes foreign investment" and the “principle of national treatment will apply to foreign investors, who would enjoy the same treatment as domestic investors". 85)

The SCOT also determined that foreign control can be exercised through service and maintenance contracts, and through additional measures other than equity ownership. The Committee was of the opinion that an examination of foreign ownership and control issues must go beyond equity considerations alone and that such issues must be analysed within a broader context. In addition, it was found that both Air Canada and CAI received financial backing from their alliance partners. It was noted that the two major CAIL were heavily dependent on these partners. Some witnesses felt that the airlines were to a large degree controlled by the alliances. Apart from the controversy surrounding the foreign ownership issue, the SCOT and Communications (SCOT) also stated that Canada's air carriers were operating within a global context and as such require new tools to survive in this environment. 86)

The Competition Bureau regarded the policy on foreign ownership as one of the largest regulatory barriers to entry, and suggested that the government may wish to reconsider this policy if a dominant carrier emerges. The Competition Bureau focused on the need for access to Foreign Capital for airlines. In their view the airline industry was capital-intensive. The Competition Bureau regarded one of the major reasons for failure in the airline industry as under-capitalisation. It was of the opinion that new entrants have a critical need for capital from both domestic and foreign sources and recommended raising the limit on foreign ownership of voting shares to 49 percent to increase access to foreign capital for carriers competing with the dominant carrier and to provide a greater incentive for foreign carriers to strike up alliances with a domestic carrier other than the dominant one. 87) The SCOT as well as the Senate Committee on Transport and Communications supported this approach. The Canadian government however retained the 25 percent limit on foreign ownership, however. 88)

The Reform Party of Canada was of the opinion that had the government increased this restriction on foreign ownership earlier, the Canadian airline industry may not have faced the dilemma of the financial position of CAIL. 89)

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The government of Canada stated that it was not convinced that raising the 25 percent limit on foreign ownership in the industry would be beneficial at that time. 90)

The proposals of the Commissioner of Competition to raise the 25 percent limit on foreign ownership of domestic airlines in Canada were supported by: • An analysis by the Independent Transition Observer on Airline Restructuring, Ward D. 91) • Stanbury WT and Ross TW of the University of British Columbia (refer to 8.22 below) who regarded the limit on foreign ownership of domestic airlines as one of the key barriers to entry that were government created. 92) Stanbury WT and Ross TW proposed an increase of the foreign investment/ownership limit from 25 percent to 49 percent in a Canadian carrier. • Air Canada, which supported the principle on the basis that it would make it easier for new Canadian carriers to attract foreign capital through equity swaps with other airlines, as long as effective control remained firmly in Canadian hands. 93) 94) • The CTA Review Panel 95 also supported it) (discussed in 8.22.9 below).

The transport minister David Collenette however informed the Canadian House of Commons, however, that the 25 percent limit on individual foreign ownership would not be changed. 96)

On 28 October 1999 the Minister of Transport Collenette D, stated that he did not “think we can allow any element of foreign competition in Canada, whether it’s via foreign-owned, Canadian operated company or under cabotage, maybe in some time, in a number of years, if the new dominant carrier becomes mature enough that it can withstand that kind of competition”. 97) This was very similar to the sentiments expressed by the then Minister of Transport in South Africa on 10 October 1997 when the possibility of participation in the privatisation of Sun Air by a large foreign airline such as BA or Singapore Airlines was ruled out on the basis that it would give them a strategic foothold in South Africa and enable them to undercut South African Airways. 98)

Although the restriction on foreign ownership in South Africa was raised to 49 percent, the then Minister of Transport that Maharaj M, preferred to see Sun Air bought by a South

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African investor or consortium. Two consortiums that included Malaysian Airlines System (MAS) and Virgin Atlantic withdrew, which left a consortium of two undercapitalised black empowerment companies, and Consolidated Network Investments (CNI) (neither of which had any experience of airline management) together with a competitor of Sun Air (BA/Comair) that won the privatisation bid for Sun Air. This method of prescriptive views with regard to ownership structure (through leveraged consortiums) in privatisation probably played a major role in the inability of Sun Air to sustain a prolonged margin squeeze due to the price leader in the market not adjusting tariffs timeously in order to pass on the effects of a declining exchange rate to customers. This aspect is discussed in 6.4.2.2 and 6.4.2.3 of chapter 6. 99)

8.8.3 THE TEN PERCENT LIMIT ON INDIVIDUAL HOLDINGS IN AIR CANADA

A court ruling that maintained the then legal limit of 10 percent of ownership of shares in Air Canada by a single shareholder proved to be the catalyst to provide control over the merger in favour of Air Canada, as a result of which Air Canada pressed forward with its bid to take over CAIL.

The SCOT as well as the Senate Committee on Transport and Communications proposed that the Air Canada Public Participation Act be amended to raise the limit of voting shares that any one entity can hold in Air Canada from 10 percent to 20 percent under certain conditions. 100) 101)

The government of Canada proposed an amendment to the Air Canada Public Participation Act to raise the limit from the level of 10 percent to a new level of 15 percent. The Canadian government stated that such limit would allow increased investment as well as providing Air Canada with the stability it needed during the transition period. 102)

8.8.4 FOSTERING COMPETITION

The Minister of Transport was of the opinion that a major consolidation (whether one major carrier or common ownership of the two carriers) in the airline industry would lessen

Chapter 8 Page 876 competition, as competitive forces would be reduced that could lead to higher prices and fewer or lower quality services.

The government of Canada wanted to create conditions that foster competition by reducing barriers to new entry, thereby encouraging existing operators and new entrants to expand into new markets, in order to mitigate the potential negative effects of consolidation of airlines in its air transport market. The Minister of Transport requested the Commissioner of Competition to provide advice on competition concerns and remedies in the event of a major restructuring of the airline industry. Such advice was included in the Canadian government's Policy framework for airline restructuring in Canada, with the objective of fostering competition by means of specific measures that were taken in a number of areas to ensure that the airline environment with a dominant carrier would be as pro-competitive as possible. Some of the remedies identified by the Commissioner were implemented as contractual commitments by Air Canada and as conditions of approval, while other remedies required government action through policy, regulatory and legislative changes. 103)

8.8.5 PROTECTING THE PUBLIC INTEREST

The SCOT was concerned about the negative effects that were frequently identified in situations of concentration including higher fares, fewer discount seats, less generous discounts, reduced frequency, service that is of a lower quality, and reduced benefits from FFPs and recommended that protective measures should be put in place. 104)

Apart from fostering a competitive environment in the restructuring of Canada's airline industry the SCOT made specific recommendations concerning public interest concerns, including safety, air fares, service to small and remote communities, financially vulnerable airports, airline employees, travel agents, the merger/acquisition review process, commitments by a dominant carrier, and a monitoring and review process, in order to address certain public interests. 105)

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8.8.6 PROTECTION OF CONSUMERS - SALIENT ASPECTS

Apart from protection of competition, the SCOT considered a number of dimensions in which the protection of consumers was important. • Financial fitness test New entrants to the airline industry must pass a financial fitness test. This requirement ensures that they have sufficient funds to sustain operations in an initial three-month start-up period without revenues from ticket sales. • Prohibition on ticket sales prior to licensing Related to this is a prohibition on ticket sales prior to licensing, which ensures that advance ticket sales cannot be used to finance the start-up of operations. • Airline alliances The Committee stated that alliances must be preserved, since their loss would reduce benefits received by air carriers, air travellers and the residents of small and remote communities. These benefits included: o Reciprocal FFPs. o Alliance member lounges. o Co-ordinated ticketing and baggage handling. o Conveniently situated connecting gates, and o Improved coordination of schedules. 106)

8.8.7 PREDATORY BEHAVIOUR

The Minister of Transport stated that “small and new entrant carriers are potentially vulnerable to excessively aggressive competitive attacks” from larger, established airlines. 107) Small carriers run the risk that a dominant carrier may try to drive them out of a market or out of business by substantially lowering fares and increasing capacity in the short run with the intention of recovering the short term losses with price increases in the long run. In early days the consumer may appear to benefit from the low prices, but the long-term result could be fewer choices and higher prices. While energetic competition is to be encouraged, predatory behaviour cannot be tolerated. 108)

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In this regard, the Competition Bureau stated that a dominant carrier in an industry with significant barriers would have both the incentive and ability to engage in various types of anti-competitive behaviour, including predation. 109)

The Competition Bureau stated that predatory conduct is intended to: • Eliminate competition. • Discipline a competitor. • To deter future entry by new competitors, and • Go beyond a normal competitive response. 110)

The Competition Bureau determined that predatory conduct in the airline industry assumes a number of different forms, including predatory pricing which occurs when an airline temporarily: • “Sets low fares to inflict losses on one or more rival airlines, or • Matches fares while adding additional capacity. • Once it has eliminated the competitor, the carrier restores higher prices”. 111)

Other predatory conduct identified by the Competition Bureau include: • “Adding flights to directly target a rival's flights. • Scheduling new flights to bracket a rival's scheduled flights”. 112)

Predatory conduct may also include: • “Increasing frequent flyer points (for example, awarding triple points). • Targeting commission overrides to travel agents for the new entrants' routes, and • Restricting access by competitors to airport facilities”. 113)

The Competition Bureau was of the opinion that these practices can occur separately or in conjunction with other anti-competitive practices. 114)

The Competition Bureau stated that the nature of the air transportation industry can allow unfair exclusionary practices to succeed. Compared to firms in other industries, a major air carrier can: • Price-discriminate to a much greater extent.

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• Adjust prices much faster, and • Shift resources between markets much more readily. 115)

A new approach to predatory conduct in the airline industry, in particular and a need for rapid response by regulatory authorities to take remedial action was necessary, according to the Competition Bureau. Given the nature of the airline industry, “new entrants could quickly be driven from the market, and in the presence of significant barriers to entry, will not be able to re-enter easily”. 116) The Competition Bureau stated that this led to a dampening effect on other potential entrants. 117)

The enforcement approach of the Competition Bureau is set out in the Predatory Pricing Enforcement Guidelines, which require the Competition Bureau to examine: • The market structure of the industry. • The barriers to entry. • Analysis of a firm's prices and costs to determine if prices are predatory. 118)

The Competition Bureau stated that given that “average variable costs in the airline industry are near zero when measured over a short period of time, establishing the criminal offence of predatory pricing for which the case must be proved beyond a reasonable doubt, was regarded as almost impossible”. 119) The then existing provisions of the Canadian Competition Act were not well suited to providing “quick relief from the impugned conduct and did not address other forms of predatory conduct”. 120) It was of the opinion that when a dominant firm is engaged in any anti-competitive act likely to prevent or substantially lessen competition in a market, the Competition Tribunal should be able to prohibit such practice or impose other remedies it deems necessary. 121)

Given the extraordinary circumstances in the airline industry, the existing provisions of the Act were regarded as inadequate by the Competition Bureau to “secure timely and effective relief”. 122) The Competition Bureau stated that it was necessary to “provide a remedy that stops the predator from killing its prey” and as a result it was essential that “interim relief can be quickly obtained”. 123) The Competition Bureau recommended that the Competition Act be amended to address airline-specific predatory behaviour, including the specification of

Chapter 8 Page 880 acts or conduct that would constitute an anti-competitive act and the power to make temporary cease and desist orders under certain circumstances. 124)

8.8.8 BARRIERS TO ENTRY

8.8.8.1 Removal of barriers to entry

According to the SCOT there was general consensus in Canada that barriers to entry should be removed as far as possible to ensure that a pro-competitive environment exists and that the opportunity must be taken to promote and create competition in their domestic air transport market, which would benefit consumers. As a result, SCOT insisted that the dominant carrier (Air Canada) must agree to respect the guidelines it proposed for reducing the barriers to entry over which it has control. According to SCOT these were: • Slots. • Airport facilities. • CRSs. • FFPs. • Interlining. • Code sharing. • Surplus aircraft. • TACOs, and • Any type of predatory behaviour. 125)

Of the abovementioned aspects, CRSs, FFPs, interlining, TACOs and predatory behaviour are discussed in following sections.

The Competition Bureau also identified the Canadian government's policies on foreign ownership and cabotage as the largest regulatory barriers to entry into the airline industry. 126) This is a controversial issue on which the Canadian government did not alter its views initially. Only following the collapse of an airline, Canada 3000, late in 2001, did the Canadian government agree to bilateral negotiations with the USA with regard to a New North American Air Policy “Open Skies Plus” which is discussed in 8.22.12 below. This was

Chapter 8 Page 881 ironic, as if a greater level of foreign investment had been allowed earlier, CAIL might have had the financial resources to survive.

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8.8.8.2 Encouraging discount carrier operations in Eastern Canada

Air Canada made the following commitments and undertakings to the Minister of Transport and the Commissioner of Competition in order to encourage discount carrier operations in Eastern Canada: • Air Canada would assign, at the option of a new discount carrier, certain facilities it recently leased at Hamilton airport to other discount carriers requiring facilities at the airport, at a price equal to Air Canada's cost. • Air Canada has agreed to refrain from establishing its own domestic airline discount service until 30 September 2001 if a Canadian discount carrier should begin serving eastern Canada. 127)

As will become evident from section 8.15 (and in particular 8.15.3.3) below, the abovementioned commitment was circumvented by Air Canada by offering seats at prices that matched the fares announced by a new low cost entrant CanJet at its launch and entry to the domestic market, which resulted in a price war in Eastern Canada. 128) The Canadian Commissioner of Competition issued a temporary cease and desist order against Air Canada on 12 October 2000 in this regard. 129) This matter is further discussed in 8.15.4 below.

Air Canada launched a no-frills service, Tango, on 1 November 2001 which essentially matched the prices of Canada 3000 on all of its principal routes, prices which had been intended by Canada 3000 to drive competitors out of business. 130) The Commissioner of Competition of Canada, stated that Air Canada's discount Tango airline was partly to blame for Canada 3000's demise. 131) This matter is further discussed in 8.21 below.

Apart from the competition implications of the actions taken by Air Canada, which are discussed in 8.15 and 8.21 below, it would appear that the termination date of the restraint was set too soon and that as a result, CanJet (which later became part of Canada 3000 as noted in 8.21) 132) was not able to establish itself on a firm basis prior to becoming a target for predatory conduct by Air Canada. As a result, the intention of the Minister of Transport and the Commissioner of Competition to encourage discount carrier operations in Eastern Canada was thwarted by the actions of Air Canada.

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8.8.8.3 FFPs

The Competition Bureau stated that FFPs are very important in attracting and retaining business travellers. Large network carriers can offer the most attractive programmes because customers have more opportunities to earn points and redeem them toward desirable holiday destinations. New entrants targeting business customers have difficulty competing because they do not have a large network. The Competition Bureau stated that new entrants can try to offer much more generous terms to earn or redeem points, but still lack a sufficient choice of destinations. 133) The Competition Bureau proposed to allow new entrants to purchase points in the dominant carrier's FFP at a cost equal to either the parent's cost or the internal transfer cost to affiliates, whichever was lower. New entrants would award such points on all domestic flights, and be allowed to award points on trans-border and international routes that, after a competitive analysis, are found to be insufficiently competitive. Points awarded by new entrants would have the same rights and privileges as those awarded by the dominant carrier. It was noted that the EC imposed similar remedies as a condition of approval of a number of alliances. 134)

The Competition Bureau stated that the disadvantage of this option was that it reinforces the dominant carrier's FFP and “builds the brand image of the dominant carrier at the expense of the new entrant”. 135) However, the new entrant would be able to spread start-up costs over a number of years and have non-discriminatory access to customer data held in the points programme. In addition, the dominant carrier would have to make clear volume and service commitments in order to maintain or expand the availability of frequent flyer seats to third- party plan members. New entrants would not be prohibited from having their own plans, nor restricted from participating in other airlines' plans. 136)

Another option considered by the Competition Bureau was to require that the dominant carrier sell the frequent flyer plans of either Air Canada or Canadian to a new entrant Canadian carrier on reasonable terms and conditions. 137)

In line with the recommendations of the Competition Bureau the Minister of Transport concluded that the potential negative effects could be mitigated by allowing any domestic

Chapter 8 Page 884 carrier to purchase points in the dominant carrier’s frequent flyer plan at a reasonable cost or by the dominant carrier’s participation in independent loyalty programmes. 138)

In terms of the commitments and undertakings made by Air Canada to the Minister of Transport and the Commissioner of Competition, Air Canada was obliged to make available its frequent flyer points to eligible Canadian air carriers on commercially reasonable terms. Airlines participating in Air Canada's frequent flyer points may still participate in other reward programmes. These points would be redeemable on all flights operated by Air Canada or any of its regional carriers. 139)

The obligation of Air Canada to make available its frequent flyer points to eligible Canadian air carriers on commercially reasonable terms did not contain any ruling with regard to the equal conditions (level playing field) within the FFP of the dominant carrier. Major difficulties highlighted afterwards included premium tier status, reserving the most valuable benefits, the one-sided offer of double or triple mileage points and the exchange of detailed information about customers.

Dorsay R highlighted another dimension of competitive application of FFPs. In his submissions on the draft enforcement guidelines on abuse of dominant position in Canada, he recommended that measures would have to be taken to ensure access to a dominant carrier's loyalty programme on equal marketing term and conditions. In the view of Dorsay R, FFPs induce a customer dependency on brand loyalty of the dominant airline that make it difficult if not impossible for new entrants to compete on a level playing field, as their customers can accrue equal loyalty programme benefits of the dominant airline, regardless of which carrier is chosen by the passenger. 140)

Dorsay R stated that there are a number of inducements in a FFP pertaining to premium tier status of a passenger that have a powerful effect on choice of carrier by a traveller. Dorsay R found that these benefits are usually more valuable than the ability to redeem points for free flights, which is typically the only benefit available to travellers without premium tier status. 141)

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These relate to: • Restricting the qualification or count of miles towards the achievement of a higher tier (status) of membership in an airline FFP by reserving the most valuable benefits for exclusively for those passengers that exclusively fly on the larger “host” airline’s own aircraft or on those of its commercial alliance partners (in the building up of so called “Q” points). 142) • Restricting benefits like access to lounges when travelling on discount fares, the right to book confirmed upgrades in advance, the ability to request a change of fight dates or departure times without incurring a price penalty, access to priority check-in, concierge services, and to special customer service phones. 143)

In the assessment of Dorsay R, participation in a dominant carrier's FFP on reasonable commercial terms by a new entrant without equal access and benefits to premium tier status and associated benefits for passengers would invariably mean that the traveller would select a carrier that offers “Q” points for their flights over one that does not. He also submitted that most passengers would opt for a carrier offering “Q” points even when things are not equal and the dominant competitor offers a significantly better schedule, better service, and/or a lower price. In his assessment loyalty programmes have and will continue to have a chilling effect on the prospects for and of new entrants. 144)

Dorsay R, also stated that carriers would frequently use a variety of promotional programmes as incentives to build loyalty and/or to build demand on weaker performing routes. One of the most common methods is to offer double or triple mileage points for flying certain routes. 145) Dorsay R, was of the opinion that it was important to ensure that new entrants that participate in the dominant carrier's FFP be able to match such incentive offerings when made in markets they serve. In his assessment a new entrant should be able to use such a loyalty programme as a tool to launch competitive initiatives in markets served by the dominant carrier on the basis of reciprocity. 146)

Dorsay R, stated that if a new entrant carrier wishes to allow passengers booking its flights to redeem points on the dominant carrier's network, dominant carriers require detailed information about the customers of the new entrant carrier. There was concern that this would allow the dominant carrier not only to target its best customers but also to do so armed

Chapter 8 Page 886 with very detailed and valuable information about its customers' travel patterns. In order to reduce such risks he recommended that smaller carriers create their own mirror loyalty programme as a filter to limit the access of the dominant carrier to the new entrant carrier's passenger data. This would allow points accrued in the new entrant's own programme to be redeemed in the dominant carrier's programme with considerably less data on customer histories being transferred to the dominant carrier. 147)

Baker JM stated that the number of FFP points a customer has with a particular airline depended not only on the amount of business the customer has given the airline and that the customer does not necessary have an incentive to fly as much as possible with the same carrier as the majority of FFP points are accumulated not by purchasing airline services but by purchasing almost “anything, in association with credit cards, through "partner" retailers, etc”. 148)

While Air Canada was required to make its frequent flyer points eligible to smaller Canadian air carriers on commercially reasonable terms, the experience referred to above was that practical problems existed that did not completely neutralise the competitive network effect of FFPs of the dominant carrier when such access was made availableto a smaller competitor.

8.8.8.4 TACOs

The Competition Bureau stated that travel agents were by far the most important distribution mechanism for air travel, accounting for more than 75 percent of ticket sales by scheduled airlines in Canada. Airlines pay travel agents base commissions on a fixed percentage of the ticket price up to a capped value. For domestic bookings, commissions are currently nine percent of the airfare, but were capped at C$50 round trip or C$30 one-way. Airlines also made additional commission payments, called override commissions when travel agents meet certain sales targets. As a result of an Air Canada announcement that it would reduce commissions to travel agents to five percent and change the cap in the amount of commission to C$60 for a round-trip ticket as of 31 December 1999, commission overrides were seen to become an even more important revenue stream for travel agents. 149)

The Competition Bureau concluded that these override commissions provide strong incentives to agents to steer business to particular carriers. In the dominant carrier scenario, Chapter 8 Page 887 the market share targets could be set so high that these override commissions would have a powerful exclusionary effect. 150)

The Competition Bureau also referred to the experience of the EC both in the recent BA abuse-of-dominance case and when setting conditions for the approval of alliances, in developing remedies to address the problems associated with override commissions. 151)

The guiding principles of the EC were that: • Travel agent compensation schemes should be based on sales volume and not be directly or indirectly tied to agent loyalty. • Commission levels should be based on distribution cost savings or the increased value of the service the travel agent provides to the carrier. • The airline agreed to increase commissions only on a straight-line basis and not tie them to previous sales (in the BA case). 152)

The Competition Bureau recommended that (for the domestic market only) the dominant carrier link its travel agent remuneration system to sales volume alone, on a straight-line basis, and not tie it directly or indirectly to travel agent loyalty. Canada should examine the principles adopted by the EC for possible application in the Canadian market. The dominant carrier should negotiate new agreements with travel agents reflecting the above conditions within six months of any restructuring. 153)

The Competition Bureau recommended that in calculating travel agent compensation, airlines should account their domestic and trans-border/international sales separately so that no incentive was created to favour domestic bookings on the dominant carriers because of volume incentives in trans-border/international markets. The dominant carrier should also implement new agreements with travel agents that reflect the above conditions within six months of any restructuring. 154)

To level the playing field Air Canada made certain commitments and undertakings to the Minister of Transport and the Commissioner of Competition to change its TACO programme so that the programme would no longer be based on revenue performance or market share for domestic services but based on Canada/USA (trans-border) and international revenues only.

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It would also no longer penalise travel agents for booking domestic flights of new entrants. The undertakings did not address the amount or level of commissions received by travel agents. 155)

Apart from the actions taken by the Competition Commission in South Africa in this regard, some guidance can be found on the specific measures adopted by the Canadian government (which measures were along the lines adopted by the EC).

8.8.8.5 CRSs

The Competition Bureau stated that CRSs are key components of airline ticket distribution that allow agents to search for suitable travel options and make real-time reservations. Initially airline owners created biased displays favouring their own flights over those of competitors. 156)

The Competition Bureau was of the opinion that there was still room for improvement of the adopted rules that remove or reduce the potential for most anti-competitive uses of CRSs in the following respects: • The display for a new entrant that has only a small network or point-to-point services would display interline connections, which would not receive as high a priority as on-line connections of the dominant carrier, even if the interline connection has a shorter elapsed travel time. This situation could be mitigated through the recommendation of mandatory code sharing. 157) • Multiple displays of the same flight due to code sharing by alliance partners lead to another problem, known as screen padding, as a flight though a connection could be displayed as two on-line connections as well as one or more interline connections. These multiple displays would often push competing travel options onto secondary screens. 158) The Senate Committee on Transport and Communications was of the opinion that this action could push information about smaller competing carriers into the background. 159) • The Competition Bureau contended that requiring that the same flight not be displayed more than twice would help prevent screen padding and the resulting crowding out of competitive alternatives. Similar rules have been imposed in a

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number of European cases and could be implemented in Canada by changing the CRS regulations under the Aeronautics Act. 160) • Many travel agents were concerned about the extent to which airlines have access to the booking information provided by CRS vendors, which result in airlines knowing the precise number of bookings each travel agent makes for each carrier on each route. The airlines use this information to target commission overrides and other incentives. It also gives all carriers very detailed information about each other's sales. The Competition Bureau was of the opinion that allowing a dominant carrier access to detailed marketing information on new carriers could increase its ability to injure competitors. 161) The Senate Committee on Transport and Communications stated that information on reservation system booking was often made known to all member airlines, a practice that could be harmful to small airlines. 162)

The Canadian government stated that it would review the CRS regulations with the carriers, the system operators and with travel agents to ensure that the regulations do not encourage anti-competitive practices either in the process of displaying airline information, or in the relationship between air carriers and travel agents. 163)

8.8.8.6 Interlining and code sharing

The Competition Bureau stated that in the dominant carrier environment, new regional entrants must be able to negotiate interline agreements to access feed traffic from the dominant carrier. This would allow a regional airline to participate in a connecting service, as the dominant carrier would have no incentive to use a new regional carrier for such a route if it had its own regional network. 164)

The Competition Bureau recommended that the dominant carrier be obliged to negotiate interline agreements on reasonable terms and conditions with all new entrants in the domestic market that wanted such agreements. 165)

The Competition Bureau recommended that code sharing in its simplest form should become an obligation of the dominant carrier. This would be an extension of the interlining agreement between the new entrant and the dominant carrier. As the ticket issuer, the new

Chapter 8 Page 890 entrant could attach its code to those flights for which it has interline agreements with the dominant carrier. 166)

The government of Canada was satisfied with the undertaking made by Air Canada to the Competition Bureau on 21 December 1999 to offer Joint Fare Agreements to any Canadian carrier. The government would incorporate these undertakings in legislation to make them legally binding and enforceable. As a result, the Canadian government did not enforce any measures relating to compulsory code sharing on Air Canada. 167)

8.8.9 DOMESTIC COMPETITION FROM FOREIGN OWNED AIRLINES

The Canadian government would revise its policies for international scheduled and charter services with a view to removing unnecessary restrictions on air services. 168)

8.8.9.1 Reciprocal cabotage

The Competition Bureau stated that along with the government's policy on foreign ownership, its policy on cabotage was identified by the Competition Bureau as the largest regulatory barrier to entry into the airline industry. The Competition Bureau suggested government reconsideration of this policy if a dominant carrier was to emerge.

The Competition Bureau proposed two approaches regarding foreign carriers providing competition in the Canadian domestic market. These were: • The modified sixth freedom service, the Montreal to Vancouver via Chicago type of route, where unlike the position today, a US carrier would be able to market a through ticket from origin to destination. • A more radical proposal, namely to allow what was referred to as "Canada-only Carriers". These could be entirely foreign owned, would employ Canadian crew and pay Canadian taxes. They would, however, not be allowed the privilege of serving international routes as a Canadian owned carrier. This approach has already been adopted in Australia. 169)

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The SCOT stated that those supporting reciprocal cabotage argued that if foreign carriers are to have access to Canada's markets in this way, their air carriers must have similar rights in foreign countries. 170)

Witnesses supporting unilateral cabotage made the point that at least some of Canada's air travellers would benefit by increased competition on domestic routes, and that they should not have to wait the potentially lengthy period of time that it might take to negotiate reciprocal rights. 171)

Those witnesses who expressed no support for cabotage did so on the basis that allowing foreign carriers, especially US carriers, access to Canada's domestic air market could financially harm some of Canada’s airlines. The point was made that cabotage would likely lead to increased competition by foreign carriers on profitable routes where there was already competition in the absence of cabotage. 172)

The SCOT understood the problems associated with cabotage. In spite of this, it thought that reciprocal cabotage would open up the market to more domestic competition, while at the same time allow Canada's air carriers to expand their markets in the USA. Along with the other barriers to entry discussed previously, cabotage must be viewed as a viable means by which competition can be fostered within Canada's airline industry. 173)

The government of Canada responded by stating that it was committed to achieving a healthy, Canadian-controlled airline industry. Should there be competition concerns in the future, the government would consider what other measures might be necessary. The Canadian government did not rule out foreign competition options as an item for future discussion, in the event that Canadian carriers cannot address competition concerns. 174)

After at first refusing to lift the 25 percent limit on individual foreign ownership of domestic airlines in Canada, Transport Minister Collenette D had to revise his view as a result of a realisation that an 80 percent market share of the domestic air transport market of the dominant airline Air Canada was unacceptable. He stated that he was prepared to: • “Re-regulate the aviation industry, or • Throw it open to foreign competition, by granting:

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o Modified sixth freedoms (modified sixth freedoms would permit US airlines to offer flights between Canadian destinations through US hubs). o Cabotage (Cabotage would allow US airlines to operate on Canadian routes)”. 175)

Submissions in this regard by the Independent Transition Observer Ward, 176) Stanbury WT and Ross TW of the University of British Columbia, 177) and general support from the CTA Review Panel 178) has already been noted in 8.22.9 below.

On 6 December 2001 Air Canada proposed a full open skies agreement between Canada and the USA to create an unrestricted, single aviation market as a new North American “Open Skies Plus” air policy for the 21st century by Air Canada. This is discussed in 8.22.12 below.

8.8.9.2 Canada-only Carriers

The Competition Bureau suggested that the creation of Canada-only carriers would provide a significant amount of competition in the dominant carrier scenario. In its view, the creation of such Canada-only carriers could contribute more domestic competition than all the other recommendations made to the Minister of Transport. By "Canada-only Carriers," the Competition Bureau meant to an airline that would be established under an Australia-like model for foreign ownership. Under this model, which would require a change to government policy regarding ownership and control, a carrier would be created that would be licensed to serve only domestic routes and could be up to 100 percent foreign owned. This model would use Canadian crews, be required to comply with all Canadian laws and regulations, and be subject to the same competitive conditions as any other Canadian carrier operating in the domestic market. The Competition Bureau believed that this would allow for greater access to foreign capital to finance Canadian airline operations and could align new entrants with knowledgeable foreign operators who have the expertise to operate as effective competitors to the dominant carrier. 179)

The SCOT stated that the Australian model should be studied in order to determine whether or not it was applicable to the Canadian situation and what regulatory/policy framework would be required. Such a review would be important in light of the prominence given to this proposal by the Competition Bureau. 180) Stanbury WT and Ross TW advocated the Chapter 8 Page 893

Australian domestic airline approach that imposed no limit on foreign ownership 181) in 8.22.5.2 below. Air Canada submitted that there were several significant differences between Australia and Canada that necessitated a different approach: • Australia was geographically isolated while Canada was not. • Canada was adjacent to one of the largest, most aggressive and competitive aviation industries in the world. • Any carrier operating in Canada and owned by US interests would be closely linked with a US carrier, or fully integrated with the US carrier. 182)

Other concerns of Air Canada related to the cost structure of US owned carriers that was much lower than that of similar Canadian carriers so that it was likely that this low cost structure would be “perpetuated” in Canada. Air Canada was also of the opinion that aircraft maintenance would take place in the USA and that as a consequence, investment would take place in the USA and not in Canada. 183) It should be noted that these were views expressed by Air Canada but the issues raised would not necessarily materialise as such issues could either be contracted (as part of granting such rights) or be regulated.

Air Canada stated that the relatively small size of Canada’s domestic air transport market made it less inviting to AA than is generally thought. In this context the small size of Canada’s domestic market was seen as the biggest barrier to new entry by AA. 184)

Canada’s regulatory and infrastructure cost base was not the same as that of the USA. In Canada domestic fuel taxes were higher and airport navigation fees were historically higher than in the US international user charges were much higher than domestic user charges in Canada. 185)

Depreciation of the Canadian dollar and workforce levels were also operational cost aspects. The substantially higher fuel prices paid by CAIL than those paid by US carriers were as a result of higher domestic fuel taxes in Canada.

There were also differences in fleet composition as well as credit worthiness/risk of the carriers. 186)

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Stanbury WT and Ross TW stated that eliminating the controls on foreign ownership (and cabotage) did not mean that the Canadian federal government would not or could not exercise notable controls over the airline industry. In this regard, the Federal Safety regulation regime would be unchanged (as it is properly independent of economic regulation). The Competition Act applies to all rivals operating in Canada, regardless of ownership and in the event of a national emergency, the federal government, by Cabinet order, could seize any aircraft on the ground in Canada and direct its use as it sees fit. 187)

The CTA Review Panel also considered the new class of domestic carrier that could be 100 percent foreign-owned (adopted in Australia) but decided rather to support the creation of a new North American “Open Skies Plus” air policy for the 21st Century. (Referred to in 8.22.12 below).

8.8.9.3 A modified sixth freedom

The Competition Bureau defined “Sixth freedom” as, the right of a carrier to carry traffic from one foreign country to another foreign country via that carrier's home country. A modified form of sixth freedom would involve taking a passenger from a foreign country via the home country back to the foreign country. In the Canadian context, this means that under a modified sixth freedom a US carrier could pick passengers up in Montreal and fly them to Vancouver via Chicago. While it was possible for a US carrier to carry passengers from Montreal to Chicago and Chicago to Vancouver, it was not possible to sell, market or display, on travel agents' CRSs, such service on a single-ticket basis.

Granting modified sixth-freedom rights would allow US carriers to sell and market a one- stop service such as Toronto–Chicago–Vancouver. This service would be inferior to a non- stop Toronto–Vancouver service and may require customs clearance that the pure domestic flight does not. 188)

The SCOT agreed that a modified sixth freedom could provide a degree of competition for a dominant carrier, it cautioned that the price would have to be significantly lower than that offered by a dominant carrier to attract sufficient traffic to bring about "real" competition on these routes. SCOT felt that the inconvenience and delays associated with going through a

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US hub would require markedly lower fares to attract large volumes of traffic away from a dominant carrier.

SCOT stated that carriers might be willing to provide sufficiently low fares to give consumers a choice, and at the same time provide price discipline on a dominant carrier. Given the significant changes that may occur in Canada's airline industry in the future, SCOT recommended that the Canadian government should take every opportunity to implement proposals that would ultimately lead to a stronger, more viable airline industry and more choices for consumers. 189)

The Competition Bureau advocated that the Minister should immediately attempt to implement modified sixth freedom rights with the USA for passenger services.

If immediate implementation was not possible, the Minister should allow modified sixth freedom rights unilaterally within two years, unless there was compelling evidence that new entrants were providing effective competition and price discipline to the dominant carrier. 190) The government of Canada stated that it was committed to achieving a healthy, Canadian-controlled airline industry. The government’s goal was to foster competition from Canadian carriers. It was doing this by ensuring that the conditions for attracting competition from new and existing carriers are in place. Should there be competition concerns in the future, the government would consider what other measures might be necessary. The government did not rule out these options as items for future discussion in the event that Canadian carriers could not address competition concerns. 191)

Stanbury WT and Ross TW also supported this approach. 192) On 6 December 2001 Air Canada proposed a full open skies agreement between Canada and the USA to create an unrestricted, single aviation market as a new North American “Open Skies Plus” air policy for the 21st Century by Air Canada. These proposals were based on the fundamental approach advocated by the Competition Bureau with regard to modified sixth-freedom rights, discussed in 8.21.5.6 below.

8.8.10 MONITORING COMMITMENTS OF A DOMINANT CARRIER

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The Minister of Transport appointed an independent observer who would monitor, review and assess the effects of airline restructuring on consumers, communities, airports, and on airlines and their employees. This individual was appointed for 18-24 months, with an optional one-year extension if necessary, and would report to Parliament through the Minister of Transport. In this report, the observer would make recommendations on, among other things, the requirement for, and scope of, any monitoring function after this transition period.

This measure would complement the government’s ongoing monitoring of the airline industry through Transport Canada’s Annual Review and in-house monitoring, Statistics Canada’s reports on data filed by the industry, and through the CTA’s licence monitoring and complaint resolution procedures. In addition, Air Canada agreed that the Commissioner of Competition would review all undertakings made by the company on 21 December 1999 in three years time and determine whether any changes to the undertakings are necessary. 193)

8.9 THE RESPONSE OF THE CANADIAN GOVERNMENT TO THE SCOT REPORT ON AIRLINE RESTRUCTURING

On 26 October 1999, the government of Canada tabled A Policy Framework for Airline Restructuring in Canada, which outlined its plan for protecting the public interest in five key areas: • Pricing. • Competition. • Canadian ownership and control. • Service to small communities, and • The fair treatment of employees. 194)

This plan identified some twenty measures for protecting the public interest, and included many of the recommendations provided to the Minister by the Commissioner of Competition for developing an environment as pro-competitive as possible. To help finalise the government’s approach, the Minister requested the advice of the Standing Committees of Parliament. In response to this request, the SCOT tabled the document Restructuring

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Canada’s Airline Industry: Fostering Competition and Protecting the Public Interest on 8 December 1999. This contained forty two recommendations for consideration by the government. 195)

The Canadian government tabled its response to the SCOT report on 17 February 2000. The government stated its commitment to ensuring that the necessary conditions are in place for attracting competition from new and existing carriers, and agreed in principle with most of the committee’s recommendations. Many of these recommendations were already reflected in the intent of the commitments and undertakings made by Air Canada to the Minister of Transport and to the Commissioner of Competition on 21 December 1999. 196)

The government of Canada had already taken action with regard to eight committee recommendations of the SCOT report by obtaining these commitments and undertakings from Air Canada. 197) The government proposed to incorporate such commitments and undertakings in legislation to make them legally binding and enforceable. These recommendations related to: • Surplus aircraft. • Interlining. • Regional affiliate divestiture. • Travel agent remuneration, and • Service to small communities. 198)

The government also announced a plan to review and liberalise Canada’s international charter policy and international air policy on 21 December 1999, which addressed recommendations in this regard. 199)

The government of Canada stated that the intent of the eleven other committee recommendations of the SCOT report had already been addressed by these commitments and undertakings made by Air Canada. 200) These recommendations related to: • Slots. • Airport facilities. • FFPs. • Code sharing.

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• Airline employees, and • Commitments by a dominant carrier. 201)

In addition, the government of Canada addressed eleven committee recommendations of the SCOT report through proposed legislation. 202) These recommendations relate to: • Predatory behaviour. • Bilingualism. • Pricing. • Notice of exit. • The merger/acquisition review process, and • The ability of travel agents to negotiate with carriers on domestic commissions. 203)

The government of Canada was taking action by means other than legislative amendments to address six committee recommendations of the SCOT report. These recommendations relate to the CRS, safety and monitoring. 204)

The government of Canada planned to take a different approach from the one taken by six of the recommendations of the SCOT committee relating to: • Ownership limits. • Airports. • Reciprocal cabotage. • Canada-only carriers, and • Modified sixth freedom rights for foreign airlines. 205)

The Canadian government did not rule out the abovementioned options for discussion in the future, should competition concerns develop that cannot be addressed by Canadian carriers. 206)

8.10 ENFORCEABLE UNDERTAKINGS TO ENHANCE COMPE- TITION IN A RESTRUCTURED AIRLINE INDUSTRY PROVIDED BY AIR CANADA TO THE COMMISSIONER OF COMPETITION

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On 21 December 1999 the Commissioner of Competition of the Competition Bureau von Finckenstein K, addressed a letter to Hunter LAW of the Barristers & Solicitors of Air Canada in which the Competition Bureau stated that the emergence of Air Canada as a single dominant Canadian airline would raise very significant competition concerns. In particular a merged Air Canada and Canadian would account for about 90 percent of domestic passenger revenues and in excess of 80 percent of domestic passengers carried. In addition, the various barriers to entry identified in a letter of the Commissioner of Competition of 22 October 1999 to the Minister of Transport remained of concern. 207)

The Commissioner of Competition stated that under the merger provisions of the Competition Act no completely preferable alternative, under the existing regulatory framework, could be found to the proposed transaction in the light of Canadian Airline’s financial situation and the undertakings provided by Air Canada. 208)

The Competition Bureau concluded that Canadian faced imminent insolvency and that there was not likely to be a competitively preferable purchaser of Canadian in the absence of the proposed transaction. Given this situation, and on the basis of the undertakings provided by Air Canada the Competition Bureau did not consider that there is a competitively preferable alternative to the transaction. As such, the proposed transaction with the undertakings was preferable to the liquidation of CAIL. 209)

The Competition Bureau stated that it continued to be of the opinoin that significant competition concerns would remain in the Canadian airline industry following completion of the proposed transaction. 210)

In the letter of 22 October 1999, the Commissioner of Competition identified four categories of recommendations designed to address competition problems. The first category, entitled “Possible Terms of Restructuring”, involved matters within the control of Air Canada and Canadian that would be to addressed by the undertakings of Air Canada. The remaining three categories involved recommendations for policy, regulatory and legislative changes which the Competition Bureau proposed in order to protect and promote competition in Canada’s airline industry. 211)

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As a result, the Commissioner of Competition did not initiate proceedings before the Competition Tribunal under their merger provisions of the Competition Act with respect to the proposed transaction. He proceeded on the basis of the mutual understanding with Air Canada that the undertakings were legally enforceable, ultimately pursuant to legislation to be introduced before the Parliament of Canada, and in the interim, if necessary, before the Competition Tribunal as a consent order. 212)

The Competition Bureau announced that Air Canada signed the enforceable undertakings designed to enhance the competitive climate in the airline industry in Canada. It stated that having determined that Canadian was facing imminent insolvency, the Commissioner of Competition decided that the merger, with undertakings, is more pro-competitive than a liquidation through bankruptcy proceedings as it was seen as the “best solution possible for consumers, under the circumstances". "Opening the market to competition from other airlines across the country will provide a valuable discipline on air fares." 213) 214)

8.11 CANADIAN AIRLINE RESTRUCTURING LEGISLATION

8.11.1 INTRODUCTION

8.11.1.1 Background

The final step in the government of Canada’s plan of action in response to the airline restructuring resulted in a Bill tabled in the House of Commons on 17 February 2000 which addressed the challenge of a radical change in the Canadian airline industry, from two national airlines competing for customers to one dominant carrier with a complete monopoly on some routes. The overriding objective of the legislation was to protect consumers and communities from monopoly behaviour and to promote competition.

The framework for restructuring proposed by the Canadian Minister of Transport was based on two overriding principles (that safety would not be compromised, and that the Official Languages Act would apply) and five key areas of public concern (pricing, fostering competition, Canadian ownership and control, service to small communities and the fair treatment of employees) that were announced in September 1999. Chapter 8 Page 901

The Canadian government also indicated that a special review process for mergers and acquisitions in the airline industry would be put in place and that the terms and conditions of approval (announced on 21 December 1999) would be made enforceable.

When it became clear that only one proposal remained on the table, that Air Canada should acquire the shares of CAIL, the government’s attention turned to a review of this proposal and on conditions for approval that were announced on 21 December 1999. The government permitted a transaction by which Air Canada acquired the shares of CAIL to take place, based on undertakings negotiated between the Commissioner of Competition and Air Canada and on commitments made by Air Canada to the Minister of Transport. According to the Minister of Transport the legislation would allow “full implementation of our Policy Framework and would enshrine measures to enforce the commitments and undertakings made by Air Canada to the Canadian government” in order to accomplish two objectives; to ensure effective consumer protection and foster competition. 215)

8.11.1.2 Introduction to the legislation and regulations

On 17 February 2000, the Minister of Transport introduced Bill C-26, as an Act to amend the CTA, the Competition Act, the Competition Tribunal Act and the Air Canada Public Participation Act and to amend another Act in consequence in the House of Commons. The Bill received Royal Assent on 29 June 2000 and came into force on 5 July 2000. 216)

Among other things, Bill C-26 specified that mergers and acquisitions of airline undertakings, including the merger of Air Canada and Canadian resulting from the transaction, had to be approved by the federal Cabinet on such terms and conditions as were considered appropriate by the cabinet and that the undertakings would be deemed to be terms and conditions of the Cabinet’s approval. 217)

The Bill C-26 also authorised the Governor-in-Council inter alia, to define, by regulation, what constitutes anti-competitive acts in the airline industry for the purpose of section 79 of the Act, and empowered the Commissioner to issue temporary "cease and desist" orders during an inquiry under the abuse of dominance provisions in respect of the airline industry. The Commissioner of Competition’s proposed cease and desist power and draft regulations Chapter 8 Page 902 defining airline specific anti-competitive acts were discussed by both the House and Senate Committees that studied Bill C-26. 218)

At hearings on 13 April 2000, the Chair of the Standing House Committee on Transport, Keyes S supported the Commissioner’s power to issue temporary cease and desist orders on the basis that a monopoly would develop in Canada and that “the competition doesn't have the luxury of waiting more than two or three days without it having a huge financial impact on its operation”. As a result, “extraordinary measures” had to be taken. 219)

On 12 April 2000, the Commissioner appeared before the SCOT of the House of Commons and tabled a draft copy of the regulations on anti-competitive acts specific to the airline industry. It was proposed that the regulations be enacted under a new subsection 78(2) of the Act. The Commissioner stated the following: • The regulations outline the type of behaviour, including predatory pricing, that was likely to be challenged because there is often a fine line divining pro-competitive behaviour from abusive behaviour. • The boundaries for the industry as to what is acceptable behaviour would be set out in the regulations. • All stakeholders were requested to forward their comments to the Competition Bureau.

In response to the Commissioner’s invitation, a number of air carriers and industry stakeholders submitted comments on the draft regulations. Air Canada did not provide the Commissioner with any comments on the draft regulations at that time. 220)

On 4 May 2000, Air Canada officials appeared before the House of Commons SCOT during its hearings concerning Bill C-26 and provided its written submissions on Bill C-26 and expressed its significant concerns over section 104.1 of the Competition Act. 221)

According to Air Canada, there was a great deal of uncertainty about what would be the legislative and regulatory regime in which Air Canada would operate after completion of the acquisition at the time the offer was made by Air Canada to purchase CAIL. Air Canada emphasised that it needed to know, in advance, the legislative and regulatory framework in

Chapter 8 Page 903 which it was to operate but that government representatives indicated that this was not possible and the transaction proceeded in the absence of draft legislation and regulations. The Undertakings of Air Canada were signed on 21 December 1999, the legislation was only introduced in February 2000 and ultimately received assent in late June 2000. Air Canada later stated that it was informed that that regulations would be introduced “respecting anti- competitive acts of persons operating a domestic service” which were meant to provide some further guidance to Air Canada. The regulations were to elaborate on the acts in the context of an abuse of dominance evaluation pursuant to section 79 of the Competition Act. Although the Commissioner approved the acquisition in December of 1999, the draft regulations were circulated to Air Canada for comment only in early summer 2000 and were ultimately enacted on 23 August 2000.

According to Air Canada, it repeatedly expressed its concerns that it had to “know the rules” and that it had to have the ability to respond to competition and that it obtained assurance from the Competition Bureau representatives that the usual rules regarding predatory pricing and abuse of dominance would apply. 222)

On 6 June 2000, Pierce R, Assistant Deputy Commissioner of Competition, tabled a revised version of the draft regulations before the Standing Senate Committee on Transport and Communications. 223)

Air Canada chose not to comment on the draft regulations on 12 June 2000 in response to questions of Senator Kirby of the Standing Senate Committee on Transport and Communications put to Milton RA, President and CEO of Air Canada. 224)

On 8 July 2000, the regulations were pre-published in the Canada Gazette. Air Canada provided comments on them at the end of July. The regulations, entitled Regulations Respecting Anti-Competitive Acts of Persons Operating a Domestic Service (the “airline regulations”), came into force on 23 August 2000. 225)

Accompanying the draft airline regulations, a Regulatory Impact Analysis Statement was published in which the Canadian government stated the following:

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• The government chose the alternative of relying on a strengthened Canadian Competition Act as opposed to a full industry regulatory regime to address the potential concerns about the ability of Air Canada to abuse its dominant market position. • This approach maintains the Canadian government’s policy on relying of competition and market forces to protect the interests of consumers. • The regulations provide clarity to industry participants by identifying anti- competitive acts that would be reviewed by the Bureau. • The regulations extended the existing abuse of dominance provisions of the Canadian Competition Act and were intended to be a code of conduct by Air Canada in as much as they specify the type of behaviour that is likely to be challenged by the Competition Bureau. • The regulations under the Canadian Competition Act did not impose any direct cost on Air Canada, or require it to seek prior approval to implement marketing or other business plans. Air Canada saw this approach as much less intrusive and less costly to both Air Canada and the Canadian government than a full industry specific regulatory regime. 226) 8.11.1.3 Regulatory impact analysis statement of the airline regulations

The regulations were made pursuant to amendments to the Competition Act which provide that the Governor in Council may make regulations specifying the following: • Acts or conduct of a person operating a domestic air service which may be considered anti-competitive acts for the purpose of section 78(1)(j) and section 79 of the Competition Act, which deals with abuse of a dominant market position, and • Facilities or services that are essential to the operation in a market of an air service for the purpose of section 78(1)(k) which provides that denial of access or refusal to supply essential facilities or services on reasonable commercial terms constitutes an anti-competitive act for the purpose of section 79. 227)

The legislation adding the amendments to the Competition Act stipulated that the Governor in Council of Canada may make the regulations on the recommendation of the Minister of Industry and the Minister of Transport. 228)

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The regulations supplement the general provisions of the Competition Act relating to abuse of a dominant market position by defining what would constitute anti-competitive conduct on the part of a dominant air carrier.

Market dominance arises where a firm has a high share of a market in which there are high barriers to entry. In other words, the firm does not face effective competition and has sufficient market power to maintain prices that are higher or quality or service levels which are lower than would otherwise exist in a competitive market.

The abuse of dominance provisions of the Competition Act sought to prohibit conduct, which would preserve, entrench or enhance a firm's market power by eliminating or disciplining a competitor or by deterring entry into the industry: • The specified anti-competitive acts to capture predatory conduct, including: o Predatory or below cost selling. o Eliminating competitors. o To deter competitors from entering a market, or o Adding capacity or using a low cost "fighting brand" carrier to achieve the same anti-competitive effect. • To address exclusionary conduct intended to foreclose the market from competition, such as: o Pre-empting airport services or facilities required by competing carriers, or o Refusing to supply essential services or access to facilities on reasonable commercial terms in circumstances where competitors have no viable alternatives. • To address the strategic use of FFPs or other marketing practices for the purpose of eliminating or disciplining competitors or deterring entry into a market. 229)

8.11.1.4 Approach adopted by the Canadian government

The Canadian government chose the alternative of relying on a strengthened Canadian Competition Act as opposed to a full industry regulatory regime to address concerns about the potential for Air Canada to abuse its dominant market position. This approach was seen

Chapter 8 Page 906 to be consistent with the government's policy of relying on competition and market forces to protect the interests of consumers.

The intention was that the regulations would provide clarity to industry participants by identifying anti-competitive acts, which would be reviewed by the Competition Bureau and the Competition Tribunal.

As a result of Air Canada's overwhelmingly dominant position in the industry (which accounted for 90 percent of domestic passenger revenues) and the ease with which a dominant airline can deploy its fleet of aircraft to target competitors with predatory prices or engage in other anti-competitive practices, the Competition Bureau concluded that the existing provisions of the Canadian Competition Act would not be adequate to address potential concerns. An amendment to the Competition Act was created to provide the Commissioner of Competition with the authority to make temporary cease and desist orders that will permit the Competition Bureau to intervene very quickly in the airline industry to prevent injury or irreparable harm to competition. 230)

8.11.1.5 Comparison of the impact of the regulations identifying the type of behaviour which could be regarded as an abuse of dominance as opposed to full industry specific regulatory regime

The regulations extended the existing abuse of dominance provisions of the Canadian Competition Act and according to the Competition Bureau could be viewed as a code of conduct as they specify the type of behaviour that would likely be challenged by the Competition Bureau. The Competition Bureau was of the opinion that the regulations under the Competition Act do not impose any direct cost on Air Canada, or require Air Canada to seek prior approval to implement marketing or other business plans. This approach was regarded as much less intrusive and less costly to both Air Canada and the government than a full industry specific regulatory regime. 231)

8.11.1.6 Consultations and proceedings in the drafting of the regulations

On 12 April 2000 the Commissioner of Competition tabled, for discussion purposes, a draft of the regulations before the House of Commons SCOT. The Commissioner invited Chapter 8 Page 907 interested parties to make their views known to the Competition Bureau and, at the same time, the draft regulations were posted on the Bureau's website.

The draft regulations were the subject of parliamentary discussion during the hearings on Bill C-26 held by the House of Commons SCOT. Concerns were raised by a number of market participants that they may not be adequate to deal with all identified potential problems, particularly refusal to deal situations. In response to such concerns, the House of Commons SCOT proposed the adoption of further amendments to section 78 of the Competition Act. The amendments dealt specifically with issues raised by industry stakeholders, including access to and supply of essential facilities and services by competitors. On 6 June 2000 the Competition Bureau tabled a revised draft of the regulations before the Senate SCOT and Communications.

On 21 June 2000, the Competition Bureau sent consultation letters and a draft of the proposed regulations to major market participants and other stakeholders inviting written comments by 14 July 2000. The consultations included nine air carriers, in addition to Air Canada and CAIL. Letters were also sent to the Air Transport Association of Canada, the Association of Canadian Travel Agents (ACTA) as well as the Consumer's Association of Canada. Five carriers as well as the ACTA provided comments supporting the substance of the regulations. The majority of the comments received discussed matters that were outside the scope of the regulations or focused on the Competition Bureau's interpretation and application of the regulations. The issues of interpretation and application were to be addressed in enforcement guidelines that the Competition Bureau would release for consultation once the regulations were in force.

On 8 July 2000 the regulations were pre-published in Part I of the Canada Gazette. This process established a fifteen-day period for comments, which ended on 23 July 2000. As part of the pre-publication process, all stakeholders had an additional opportunity to provide comments to the Bureau. The pre-publication of the regulations in the Canada Gazette attracted the attention of the media, which continue to take a high level of interest in issues related to the airline industry. Media stories focused on the application of the regulations to Air Canada under the Competition Act and timing issues.

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Air Canada provided comments in response to pre-publication in the Canada Gazette. Air Canada wished to obtain assurances from the Commissioner of Competition that the regulations did not alter the basic test for abuse of dominance under section 79 of the Competition Act and that the general provisions of section 79 would be enforced against the activities of foreign air carriers where circumstances warrant. Air Canada also sought clarification with respect to the relationship of the regulations to undertakings that it provided to the Competition Bureau as part of the Bureau's review of the merger between Air Canada and CAIL. The Commissioner indicated his position on the matters to Air Canada and further indicated that a number of issues raised by it as to the application and interpretation of the regulations will be discussed in the Bureau's enforcement guidelines. The undertakings provided by Air Canada, in regard to the merger, were pro-competitive, legally binding obligations of Air Canada. The Competition Bureau ruled that any actions taken by Air Canada and its affiliates that are required by the undertakings will not be considered as "anti- competitive acts" within the meaning of section 79 or the regulations. However, compliance with the undertakings regarding the merger will not otherwise shield Air Canada from the application of section 79 and the regulations thereto.

On the basis of a review of all of the comments received by the Competition Bureau and following consultations with the Departments of Transport and Justice, clarifying changes were made to the final regulations. The essential substance of the regulations however remained unchanged from those published in the edition of the Canada Gazette of 8 July 2000. 232)

8.11.1.7 Institutional arrangements relating to compliance and enforcement

The Competition Bureau and the Competition Tribunal are responsible for the enforcement and administration of the regulations in Canada. Where the Commissioner of Competition believes that Air Canada engaged in conduct that is contrary to the regulations, the Competition Bureau can carry out a formal inquiry and, where grounds warrant this file an application for an order of the Competition Tribunal prohibiting the conduct or imposing other sanctions necessary to overcome the impacts on competition.

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In most instances, the Commissioner will be acting on a complaint. The Competition Act provides formal powers of investigation, including search and seizure and subpoena powers to obtain written and oral evidence.

To succeed in an application under the abuse of dominance provisions, the Competition Bureau must satisfy the Competition Tribunal that: • The firm in question is, by virtue of a high market share and barriers to entry into the industry, dominant to such a degree that it can influence prices in a relevant market. • The firm has engaged in a "practice of anti-competitive acts" defined as the type of conduct which would constitute a "practice of anti-competitive acts" in the context of the airline industry defined in the regulations, and • The result is "substantial prevention or lessening of competition."

The regulations did not, however, alter the test of market dominance or a substantial impact on competition that the Competition Tribunal must find before it can make an order. 233)

8.11.1.8 Overview of the regulations

The Regulatory Impact Analysis Statement explained the context for the regulations and the way in which the definitions of anti-competitive acts “fit” an abuse of dominance analysis.

To succeed in an application under the abuse of dominance provisions, the Competition Bureau must satisfy the Competition Tribunal that: • The firm is, by virtue of a high market share and barriers to entry into the industry, dominant to such a degree that it can influence prices in a relevant market. • This firm has engaged in a “practice of anti-competitive acts”, and • The result is “substantial prevention or lessening of competition”. 234)

The proposed regulations defined the type of conduct that would constitute a “practice of anti-competitive acts” in the context of the airline industry but did not alter the rest of market dominance or a substantial impact on competition, which the Competition Tribunal had to find before it could make an order.

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The regulations listed a number of anti-competitive acts for the purpose of the provision of the definition (section 78) in relation to the abuse of dominance.

With respect to pricing issues, the regulations stated that for the purposes of section 78(1)(j) of the Competition Act, the following acts or conduct of a person operating a domestic air service (as defined in subsection 55(1) of the CTA), were anti-competitive acts: • Operating capacity on a route at fares that do not cover the avoidable cost of providing the service. • Increasing capacity on a route or routes at fares that do not cover the avoidable cost of providing the service.

There was no definition of avoidable cost in the regulations. 235)

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8.11.2 CONSUMER PROTECTION

The Minister of Transport stated that an overriding objective was to ensure that consumers would be effectively protected from any abuse by a dominant carrier. As a result, specific measures to deal with monopoly pricing, conditions of carriage, market exit, official languages and monitoring were proposed. 236)

8.11.2.1 Monopoly Pricing

The Minister of Transport stated that as a result of concern of Canadians, living in small, rural and remote areas of the country, the government would not tolerate price gouging. As a result, regulatory oversight of pricing behaviour on monopoly routes would be increased.

Increased powers were granted to the CTA to address complaints on prices on monopoly routes in order to review all passenger fares as well as cargo rates. The Agency would continue to have the power to disallow, or roll back a fare or a fare increases and to order a carrier to add classes of fares if they are absent on monopoly routes, but available on similar competitive routes operated by the carrier elsewhere in the country. The Agency has the authority to review prices, on its own initiative for two years, with a possible extension of two years by the Governor in Council.

The Minister of Transport was of the opinion that this was a “tough but balanced approach” in order to protect consumers from price gouging but also ensure that airlines are free to compete at home and abroad, which is ultimately the best guarantee of reasonable prices. The objective was to ensure that fares were reasonable and that there was an appropriate choice of fares on monopoly routes. The Agency would be monitoring the situation on its own accord and be empowered to take action as necessary. 237)

8.11.2.2 Conditions of carriage

The Canadian government also proposed to grant the CTA the authority to review the terms and conditions of carriage on domestic service dealing with certain aspects affecting passengers, such as lost baggage and being bumped from flights on the same basis as the same authority exists on international services. Chapter 8 Page 912

The objective of the measure was that the Agency would ensure that the carriers have, and apply, terms and conditions that are reasonable and non-discriminatory and will allow the Agency to suspend, disallow or require substitutions to those terms and conditions, as well as to order compensation of expenses for persons who have been adversely affected. 238)

8.11.2.3 Commitment on service - notice of exit

The Minister of Transport also proposed new notice of exit provisions to provide for dialogue between carriers and communities. These would require an airline to give 120 days’ notice if it plans to withdraw or significantly reduce service on a route instead of the then existing requirement to give 60 days' notice.

This would provide an opportunity for elected officials of the community to meet with the airline to discuss the impact of the proposed reduction or discontinuance of service.

The measures were designed to minimise or prevent service disruptions, and to ensure that consumers were well informed if there are any plans to discontinue or reduce service.

This measure was taken to ensure that the commitment of Air Canada to continue domestic service to communities being served by Air Canada, CAIL for a three-year period would be legally binding and enforceable. 239)

8.11.2.4 The Canadian Official Languages Act

A proposal to amend the Air Canada Public Participation Act would give Air Canada the responsibility for ensuring that services provided to customers by its air service affiliates comply with the Official Languages Act. This was done in recognition of the unique Canadian culture and values. 240)

8.11.2.5 Monitoring

The consumer protection measures were the end product of a process that involved the input of Parliamentarians, the Competition Bureau, the CTA. The measures were regarded as part of an “effective package” but their implementation had to be properly monitored. Chapter 8 Page 913

The Minister of Transport decided to appoint an independent person to observe and report on the impacts of airline restructuring over the next 18-24 months. This person had to observe the behaviour of all the players (the carriers, consumers, the Agency, the Competition Bureau, and the DOT) with a view to reporting to parliament on how airline restructuring was being handled during this transition phase. 241)

8.11.3 FOSTERING COMPETITION

The second objective of the legislation was to foster competition.

8.11.3.1 Undertakings made by Air Canada

The undertakings made by Air Canada to the Commissioner of Competition on 21 December would be made legally binding and enforceable by the legislation.

The undertakings required Air Canada to inter alia: • Surrender slots and facilities at airports. • Sell surplus aircraft to Canadian operators. • Try to sell Canadian Regional Airlines Limited. • Provide access to its FFP. • Provide access to interlining and joint fare agreements. • Change the way incentive override commissions are paid to travel agents, and • Refrain from starting any discount air carrier operations in Eastern Canada for a specified period of time.

Failure to comply with any of the undertakings or commitments would result in a maximum penalty of five years' imprisonment or C$10,000,000 or both. 242)

8.11.3.2 Predatory pricing

The Minister of Transport supported the Commissioner of Competition in ensuring that predatory behaviour in the air services sector is properly identified, monitored and enforced. Legislation was introduced to strengthen the Competition Act with the intention of allowing

Chapter 8 Page 914 the Governor in Council to define, by regulation, anti-competitive acts or predatory behaviour in the airline industry. The Commissioner of Competition was granted the power to issue temporary cease and desist orders in cases of predatory behaviour in the airline industry as it was recognised that there was a need for quick action to prevent a dominant airline from engaging in any conduct which would damage competitors or exclude them from the market place. 243)

8.11.3.3 Travel agents

The Minister of Transport stated that the Canadian government had also considered the needs of the travel agent community. The Commissioner of Competition’s initiative to give the travel agent community an exemption from the Competition Act to allow them to negotiate more effectively with a dominant carrier on domestic commissions was supported by the Minister of Transport. The intention of this measure was designed to provide a level playing field between travel agents and the dominant carrier. 244)

8.11.3.4 Fair treatment of employees

Air Canada’s commitment to ensure that no involuntary layoffs or relocation of unionised employees of Air Canada, CAIL or their wholly owned subsidiaries for a two-year period would now be legally binding and enforceable, was also incorporated in the legislation. 245)

8.11.3.5 Safety

The Minister of Transport re-affirmed that safety remains a paramount objective and will not be compromised under any circumstances. A programme "Flight 2005" was launched to establish a safety framework for the next five years. The intention was that the framework would aim to reduce Canada’s low accident rate by establishing specific safety targets and expected key results. 246)

8.11.4 CONCLUSION

The Minister of Transport was of the opinion that a legislative package had been developed that safeguarded the public interest while promoting a viable Canadian airline industry. Chapter 8 Page 915

Effective protection would be provided for consumers and for communities, at the same time creating conditions for the airlines to compete freely at home and abroad, serving all parts of the country at fair prices, and controlled by Canadians for Canadians.

8.11.5 SUMMARY RELATING TO CANADIAN AIRLINE RESTRUC- TURING LEGISLATION

Collenette DM, Minister of Transport, tabled legislation in the House of Commons to deal with airline restructuring together with the Canadian government’s response to the airline restructuring report from the SCOT

The legislation addressed elements of the government’s plan for protecting the public interest contained in the report, A policy framework for airline restructuring in Canada, which could not be implemented without amendments to existing legislation.

The new consumer protection measures included: • Increased powers for the CTA to prevent price gouging. • Restored powers for the CTA to deal with conditions of carriage for domestic service (including lost baggage and bumping). • Improved notice of exit provisions to minimise or prevent service disruptions, and ensure dialogue between airlines and communities. • A requirement that services provided to customers by Air Canada and its air service affiliates comply with the Official Languages Act where there is significant demand. • The appointment of an independent observer who would monitor and assess the impact of airline restructuring over the next 18-24 months and report to Parliament through the Minister of Transport. government oversight was increased on monopoly routes in order to protect consumers from price gouging; the agency could disallow or roll back any unreasonable fares.

New measures to foster competition included: • New powers for the Competition Bureau to regulate anti-competitive behaviour in the airline industry.

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• New powers for the Competition Bureau to issue temporary orders to stop predatory behaviour. • A prohibition of exclusive use clauses in confidential contracts for domestic service to encourage competition for corporate travel, and • More freedom for travel agents to negotiate more effectively with a dominant carrier on domestic commissions.

These measures complemented the undertakings made by Air Canada to the Commissioner of Competition to ensure access to markets by competitors. 247)

It is evident that the Canadian government implemented a number of regulatory instruments and institutional arrangements in order to foster competition and to provide measures for additional consumer protection. These measures were seen to be necessary in order to set off the effect of dominance in the market in that a dominant airline would be able to act independently of regard to its customers.

8.12 ENFORCEMENT GUIDELINES ON THE ABUSE OF DOMINANCE IN THE AIRLINE INDUSTRY

8.12.1 AIRLINE REGULATIONS (CODE OF CONDUCT) ENACTED FOLLOWING RESTRUCTURING OF THE CANADIAN AIRLINE INDUSTRY

The Competition Bureau regarded the airline regulations that were enacted following the restructuring of the Canadian airline industry for air carriers as a ‘code of conduct’ with the objective of ensuring a transparent and predictable enforcement policy. It was intended to inform all industry stakeholders about the type of conduct that the Competition Bureau was likely to challenge in order to facilitate as high a degree as possible of compliance with the airline amendments to the Competition Act and the related regulations, thereby minimising the need for enforcement action under the Competition Act.

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Owing to the large degree of market dominance of Air Canada (more than 80 percent of domestic passenger traffic and close to 90 percent of domestic passenger revenues in December 1999) the government concluded that additional safeguards, beyond those available under the existing provisions of the Competition Act and undertakings provided by Air Canada as part of the merger approval process, were necessary to protect the competitive process.

There was recognition by the Canadian government and the Competition Bureau that a dominant carrier could have an incentive to engage in anti-competitive behaviour, but also that certain characteristics of the airline industry (e.g. highly mobile assets) would provide an opportunity for a dominant carrier to do so wherever existing competitors expand or new competitors emerge to challenge its dominance. 248)

To address these concerns, the Canadian Competition Act was amended to provide authority for the Governor in Council to specify, by regulations under section 78(2)(a) of the Competition Act, anti-competitive acts or conduct on the part of a person operating a domestic airline service as defined in subsection 55(1) of the CTA. A further amendment contained in section 78(1)(k) relating to access to and supply of essential services and facilities was also introduced together with authority for the Governor in Council to specify by regulations services and facilities that are essential for the purpose of applying this provision. These regulations came into force on 23 August 2000. 249)

The Competition Act was further amended to allow the Commissioner of Competition to issue temporary orders in the airline industry under certain specified circumstances. The purpose of this additional power contained in section 104.1 of the Act is to enable the Commissioner to intervene to prevent injury to competition, the elimination of a competitor or loss by a competitor of significant market share or revenue between the time when an inquiry under the Act has commenced and when the matter can be brought before the Competition Tribunal in the form of an application under section 79.

The undertakings provided by Air Canada as part of the merger approval process were regarded as pro-competitive, legally binding obligations on the part of Air Canada.

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The Competition Bureau stated that any actions taken by Air Canada and its affiliates which are required by its undertakings would not constitute "anti-competitive acts" within the meaning of section 79 of the Competition Act or as defined in the airline regulations but compliance with the undertakings regarding the merger would not otherwise shield Air Canada from the application of section 79 or the regulations. 250) The airline specific amendments and regulations under the Competition Act defined the “boundary between legitimate and unacceptable conduct” by the dominant airline carriers. It is submitted that this approach has the benefit of providing clarity on the “rules of the game” for all participants.

The Competition Bureau recognised: • The difficulty associated with distinguishing anti-competitive behaviour from aggressive, but beneficial, competition in the marketplace, and • The need to ensure that the application of these provisions does not unduly hinder the competitive process.

The Competition Bureau also stated that the regulations defining anti-competitive acts by a dominant air carrier were not intended to inhibit Air Canada or any other carriers from competing for the business of Canadian air travellers, nor were they intended to protect airline carriers from competition. 251)

8.12.2 ANTI-COMPETITIVE ACTS DEFINED BY LEGISLATION AND REGULATIONS

Predatory, exclusionary and other conduct defined by regulation as anti-competitive when carried out by a dominant airline carrier included the following: • Capacity on a route or routes at fares that do not cover the avoidable cost of providing the service. 252) • Increasing capacity on a route or routes at fares that do not cover the avoidable cost of providing the service. 253) • Using a low-cost second-brand carrier in a manner that is described in either of the preceding sections. 254)

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• Pre-empting airport facilities or services that are required by another air carrier for the operation of its business, with the object of withholding the airport facilities or services from a market. 255) • To the extent not governed by regulations respecting take-off and landing slots made under any other Act, pre-empting take-off or landing slots that are required by another air carrier for the operation of its business, with the object of withholding the take-off or landing slots from a market. 256) • Using commissions, incentives or other inducements to sell or purchase its flights for the purpose of disciplining or eliminating a competitor or impeding or preventing a competitor's entry into, or expansion in, a market. 257) • Using a loyalty marketing programme for the purpose of disciplining or eliminating a competitor or impeding or preventing a competitor's entry into, or expansion in, a market. 258) • Altering its schedules, networks, or infrastructure for the purpose of disciplining or eliminating a competitor or impeding or preventing a competitor's entry into, or expansion in a market. 259)

In addition, section 78(1)(k) of the Competition Act specified an additional anti-competitive act under section 78, the denial by a person operating a "domestic service", as defined in subsection 55(1) of the CTA, of access on reasonable commercial terms to facilities or services that are essential to the operation of an "air service" as defined in that subsection, or refusal by such a person to supply such facilities or services on such terms. 260)

Facilities and services that are essential to the operation in a market of an air service are defined by regulation as those: • That are required in order to provide a competitive air service. • That cannot reasonably or practicably be purchased, acquired, provided or replicated by another air carrier on its own behalf. • That are effectively controlled by the air carrier who denies access to them or refuses supply of them, 261) and • That can be feasibly provided to another air carrier, having regard to operational or safety considerations, or legitimate business justifications of the air carrier referred to above. 262)

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Facilities and services included, but were not limited to, take-off and landing slots, interline arrangements, airport gates, loading bridges, counters and related airport facilities, maintenance services, and baggage handling infrastructure, equipment and services. 263)

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The abuse of dominance provisions provided broad powers of remedy to the Competition Tribunal that included the ability to: • Make an order prohibiting a respondent firm or firms from engaging in the practice of anti-competitive acts, and • Make an order directing any such actions, including the divestiture of assets or shares, as are reasonable and necessary to overcome the effects of the practice of anti- competitive acts in cases where the Competition Tribunal concluded that such an order may not be adequate to restore competition. 264)

The role of the Competition Bureau was to carry out investigations under the Competition Act having regard for the public interest associated with competition. Apart from limited authority granted to the Commissioner of Competition to issue temporary orders in respect of the airline industry, the Competition Bureau did not have the authority to directly compel change in business behaviour. In order to do so, it had to make an application to the Competition Tribunal and take on the role of a litigant. 265)

8.12.3 COMPETITION TRIBUNAL ORDER RELATING TO THE ABUSE OF DOMINANCE PROVISION

8.12.3.1 Introduction

An abuse of a dominant position was seen to occur when a dominant firm in a market, or a dominant group of firms acting together, engaged in conduct that was likely to: • Eliminate or discipline a competitor. • Deter future entry by new competitors, with the result that competition would be substantially prevented or lessened. 266)

8.12.3.2 Essential elements for the grant of an order by the Competition Tribunal

The intention of section 79 was not to prohibit dominance or the presence of market power but to address the "abuse" of a dominant market position to substantially prevent or lessen competition. Three essential elements had to exist before the Competition Tribunal could

Chapter 8 Page 922 grant an order: • One or more firms are dominant in that they substantially or completely control a class or species of business. • The firm, or firms, have engaged in or are engaging in a practice of anti-competitive acts. • The practice of anti-competitive acts has had, is having, or is likely to have the effect of preventing or lessening competition substantially in a market. 267)

8.12.3.3 Establishment of Grounds for an Inquiry by the Competition Bureau

Upon the receipt of a complaint by the Competition Bureau, a determination would be made as to whether the complaint is likely to warrant a formal inquiry under the Act. This determination required reason to believe that anti-competitive acts had occurred which were likely to result in a substantial prevention or lessening of competition.

The grounds for an inquiry by the Competition Bureau (reason to believe) was to be the provision of information from a complainant relating to the specific conduct being complained about and its impact on competition. The Competition Bureau can invoke its formal powers under the Competition Act to require the production of the relevant information by all market participants. 268)

8.12.4 PROCEDURAL INVESTIGATION BY THE COMPETITION BUREAU

The Competition Bureau must establish the following when examining an allegation of abuse: • Whether an air carrier is dominant in that it "substantially or completely controls, throughout Canada or any area thereof, a class or species of business". • The Competition Bureau gave notice that it would treat the elements "class or species of business" as being synonymous with a relevant product market and the element of "throughout Canada or any area thereof" as being synonymous with a relevant geographic market.

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• The Competition Bureau also considered dominance to be synonymous with market power. • To determine whether a firm possesses market power, the Competition Bureau would assess a number of qualitative and quantitative factors, of which the most important were market share and barriers to entry. 269)

The approach adopted by the Competition Bureau, relating to market definition, geographic market, product market in the airline industry, is set out in annexure “AE” attached hereto.

8.12.5 PRACTICE OF ANTI-COMPETITIVE ACTS IN THE AIRLINE INDUSTRY

The second element required under section 79 of the Competition Act is to establish that the firm or firms in question have engaged in a practice of anti-competitive acts, which could include one occurrence that is sustained or systematic over a period of time, or a number of different acts taken together that have an anti-competitive effect. 270)

The Bureau's interpretation of the specific airline anti-competitive acts referred to in section 78(1)(j) and 78(1)(k) of the Competition Act and the Bureau's approach to ascertaining whether they have taken place is summarised below.

8.12.5.1 Operating/increasing capacity at fares below avoidable cost

The following behaviour was defined as anti-competitive acts in the regulations 1 (a), (b) and (c): • Regulation 1(a) Operating capacity on a route or routes at fares that do not cover the avoidable cost of providing the service. • Regulation 1(b) Increasing capacity on a route or routes at fares that do not cover the avoidable cost of providing the service. • Regulation 1(c) Using a low-cost second-brand carrier in a manner that is described in any of the two ways above. 271)

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The regulations generally stated that in the airline industry operating or increasing capacity on a route or routes, at fares that do not cover the avoidable cost of providing the service constitutes an anti-competitive act. 272)

The Competition Bureau stated that pricing and capacity decisions of a dominant carrier will have an anti-competitive effect if they result in higher prices and reduced output as a result of the elimination or disciplining of a rival, or the exclusion of a potential rival. 273)

The Competition Bureau identified two examples of such conduct: • A dominant airline may offer a large number of seats at low fares on a route on which it faces competition. As a result of such conduct, one or more of the airline's competitors may be driven from the market. Such conduct may also deter remaining airlines from engaging in aggressive fare competition, or deter other airlines from entering routes on which the incumbent airline operates. 274) • A dominant airline may increase capacity on a route in such a way as to attract passengers from a rival carrier, while not attracting a sufficient number of passengers to cover its avoidable costs. 275)

The Competition Bureau stated that in its experience most complaints under regulations 1 (a), (b) and (c) was expected to come from established carriers or new entrants alleging that the dominant firm has responded to their entry or expansion in a market by "targeting" them with lower prices or some other competitive variable. While the Competition Bureau closely examines allegations of targeting, the focus of the Bureau's inquiries is whether the revenues earned from passenger fares, cargo services and other sources are sufficient to cover the avoidable cost of the dominant carrier in providing the service. 276)

The Competition Bureau stated that the practice of operating capacity at fares that do not cover the avoidable cost of providing the service does not require that the fares charged by the dominant airline be lower than the fares set by the competitor in order to be considered anti-competitive. In its view airlines differ in many ways, such as in the quality of service they provide, the schedule they offer, and their FFP. The Competition Bureau did not consider that matching the dollar price of a competitor for travel on a specific flight the same as charging the same real price for the same quality and quantity. An airline with a superior

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FFP or schedule could meet the dollar price of a competitor, and in fact force the rival to set substantially lower fares to attract customers. In the Bureau’s opinion price matching can be anti-competitive, where the revenues earned by the service fall below the avoidable cost of providing the service. 277)

8.12.5.1.1 The avoidable cost test

The Competition Bureau stated that the avoidable cost test compares the revenues earned as a result of providing a service to the avoidable costs of providing that service. The avoidable costs were defined as referring to all costs that could have been avoided by the dominant airline had it chosen not to offer the service in question. The Competition Bureau stated that it would conclude that the airline is engaging in anti-competitive conduct if the revenues the dominant airline earns from the service do not cover the avoidable costs of a particular service. 278)

The Competition Bureau stated that in the airline industry, the relevant unit of capacity for cost and revenue analysis is a flight. Carriers adjust capacity by adding and subtracting flights or by changing the size of the aircraft used to provide the service. Carriers can and do cancel badly performing flights such as those with low load factors and those with revenues that do not cover cost. Badly performing flights are sometimes removed from a route even if the overall route is profitable. Alternatively, a carrier could maintain an unprofitable flight on an otherwise profitable route for the purpose of drawing passenger traffic away from a rival carrier. The latter act could lead to the disciplining or elimination of a competitor from the route.

Under the avoidable cost test, the Competition Bureau considers whether the revenue from each flight on a route covers the avoidable cost of the flight on a daily basis for a period of at least a month.

The term "flight" would refer to departures on a city-pair route that occur at identical or similar times for the purpose of the Guidelines. As common costs are incurred in providing airline service, the Competition Bureau did not consider it appropriate to conduct the avoidable cost test by comparing a particular fare with the avoidable cost of a flight averaged over all the seats in the aircraft. Chapter 8 Page 926

Where an airline respond to entry by adding a new flight to a route on which it has previously offered service, the calculation of avoidable cost would include all costs that the airline had to incur to offer the additional flight. These would include: • All costs that vary with the number of passengers served, as well as • Those costs that need to be incurred to operate the flight but that do not vary with the number of passengers carried on the flight.

As a general rule, the Competition Bureau would, rather than focus on a specific fare class, apply the cost-revenue analysis under the avoidable cost test to flights. In this regard, the Competition Bureau recognised that a carrier such as Air Canada has numerous fare categories on any given flight. Rather than focus on a specific fare class, the relevant issue would be whether the total revenue earned from a flight is sufficient to cover the avoidable cost of providing the flight. 279)

8.12.5.1.2 Cost classification by the Bureau

Avoidable costs would include the following: • Costs that vary with the number of passengers served and would include costs such as passenger commissions, some portion of fuel and oil expense, food and supplies. • Flight specific fixed costs would also be avoidable unless they would still be incurred or could not be reallocated in the event the flight is cancelled including base fuel, flight and cabin crew costs, aircraft costs, navigation fees, landing fees, maintenance labour and aircraft service labour. 280)

Avoidable costs would not include any common costs that the airline needs to incur to offer service beyond the flight in question. For example, common costs may include fixed overhead costs, such as maintenance facilities, corporate offices, and executive salaries that are required to offer any service from a particular city.

Whether a cost is considered avoidable will depend on the length of time required by the airline to adjust its schedule and its capacity in the market as an incumbent carrier might anticipate where and when entry will occur several months in advance of the actual

Chapter 8 Page 927 commencement of the entrant's service and add a flight in a market in anticipation of a rival carrier's entry. Alternatively a flight might be maintained in a market when it would otherwise have been cancelled in the absence of an entry threat. In such cases, the incumbent carrier's aircraft costs and other associated flight specific costs would likely be regarded as avoidable for a flight by the Bureau. The Competition Bureau would examine whether the revenue generated by the fares for a given flight cover the avoidable cost of the flight with respect to the airfares that do not cover the avoidable cost of providing the service.

The Competition Bureau would use a daily basis to calculate its revenue/avoidable cost comparison. For any given flight the Competition Bureau would consider whether that flight's average daily revenues over a month cover its avoidable costs, as well as the number of times that flight's revenues did not cover its avoidable costs. 281)

8.12.5.1.3 Categories of avoidable cost

The information summarised in the tables contained in annexure “AF” contain a summary of information on how the Competition Bureau was likely to categorise various costs as either avoidable or unavoidable with respect to the airline's decision to cancel or add a flight. The costs were grouped into four general categories: outright avoidable, avoidable through redeployment, potentially avoidable and unavoidable. Some costs were not exclusive to a single category, for example; aircraft costs could be avoidable either outright through sale or through redeployment to other routes. 282)

8.12.5.1.4 Low-cost second-brand carrier

In the case of a dominant carrier introducing a low-cost second-brand carrier, as described in regulation 1 (c), the Competition Bureau stated that it would adopt a similar approach to determine whether or not it is operated below avoidable cost. 283)

The Competition Bureau stated that if a complaint had led it to believe that the dominant air carrier is using a low-cost second-brand carrier to engage in an anti-competitive act, it would closely examine the low-cost carrier's costs to determine whether it is receiving the benefit of Chapter 8 Page 928 any cross-subsidy from the mainline carrier for services or other inputs to its operations that would facilitate anti-competitive behaviour. 284)

The Competition Bureau stated that a cross subsidy from the mainline carrier could take the form of cost shifting from the low-cost carrier to the mainline carrier which would result in an understatement of the low-cost carrier's true economic costs of operation. It could be done to signal a potential entrant that its costs are lower than they really are, or to pass an avoidable cost test. The Competition Bureau stated that it would compare a low-cost second- brand carrier's costs to those of the mainline carrier with the object of determining whether reported cost differences were factual. 285)

8.12.5.2 Exclusionary conduct

Regulations 1 (d), (e) and (h) defined the following exclusionary conduct as anti- competitive-acts: • Regulation 1 (d), pre-empting airport facilities or services that are required by another air carrier for the operation of its business, with the object of withholding the airport facilities or services from a market. 286) • Regulation 1 (e), to the extent not governed by regulations respecting take-off and landing slots made under any other Act, pre-empting take-off or landing slots that are required by another air carrier for the operation of its business, with the objective of withholding the take-off or landing slots from a market. 287) • Regulation 1 (h), altering its schedules, networks, or infrastructure for the purpose of disciplining or eliminating a competitor or impeding or preventing a competitor's entry into, or expansion in, a market. 288)

The Competition Bureau defined exclusionary conduct as conduct by an incumbent firm to keep potential rivals from entering its markets or to keep existing rivals from expanding in one or more markets. The Competition Bureau stated that an incumbent firm could take control, on a pre-emptive basis, of essential inputs, services, or facilities required by a rival firm to compete with the incumbent, raising a rival's costs of providing service, or contracting with customers so as to preclude them from becoming customers of a rival firm. 289)

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8.12.5.2.1 Pre-empting airport facilities

In the Bureau's view, the anti-competitive act defined in regulation 1 (d), "...pre-empting airport facilities or services that are required by another air carrier for the operation of its business..." applies to the situation where a dominant carrier obtains access to and control of certain airport facilities or services (e.g., gate space, counter space, baggage handling facilities) before a competing carrier has an opportunity to enter into or expand in the market. The Competition Bureau stated that "market pre-emption" is normally based on the idea that an investment is being made before it can yield a positive return on a flow basis. Hoarding of inputs essential for the production of a good or service, in order to keep them from being used by a potential rival, would be regarded as a pre-emptive act if the inputs were not immediately contributing towards higher returns for the firm. As such, the firm would have acquired the essential inputs or production capacity in excess to its present requirements in order to keep new entrants out of the market. According to the Bureau, the objective of pre- empting the market and keeping new firms from entering, was that the dominant carrier will be able to charge higher fares and earn higher profits than would have been possible if new entry had occurred. 290)

8.12.5.2.2 Pre-empting takeoff landing slots

The anti-competitive act defined in regulation 1 (e), "...pre-empting take-off and landing slots that are required by another air carrier for the operation of its business . . ." is similar to anti- competitive act described in the previous section in that pre-emption is the objective. Airport slots were distinguished from airport facilities and services as they may be regulated. The Competition Bureau defined an airport slot as a scheduled time of arrival or departure available or allocated to a particular airline on a specific date at an airport. A dominant carrier's pre-emption of slots would imply acquiring control of slots that it had no immediate use for, but that it wished to hold in order to keep entrants out of the market. 291)

The Competition Bureau was of the opinion that if the carrier had to use the slots in order to maintain control of them, it might also be able to schedule some service in the slots just to occupy such slots (even if the service operates at a loss). Pre-emption of this nature was identified as pre-emptive scheduling by the Competition Bureau that involved the expansion Chapter 8 Page 930 of capacity in the market at a time before it can generate at least a competitive rate of return on a flow basis. In the absence of potential entry by a new carrier into the market, the incumbent carrier would have no incentive to expand capacity prematurely because its overall profits would be higher by delaying the increase in service until market growth justified it. It is the threat of new entry that drives the incumbent to expand its capacity, and the capacity expansion acts as an entry barrier.

The Competition Bureau stated that with a "use it or lose it" slot allocation policy, in terms of which the Competition Bureau would determine whether a dominant carrier has pre-empted take-off and landing slots on the basis of whether the carrier is covering the avoidable cost of offering the service in the slots for which pre-emption is alleged. The Competition Bureau stated that in order for pre-emption of take-off or landing slots to be an anti-competitive act, it need to have been done with the object of withholding the take-off or landing slots from a market. 292)

The Competition Bureau was of the view that pre-emption of slots could adversely affect competition at airports where the pre-empted slots are arrivals or departures during the peak travel periods, or at airports that are slot constrained. The Competition Bureau identified Toronto's Pearson Airport as the only Canadian airport that faces slot constraints. It was however envisaged that slot constraints could develop at Vancouver or Dorval airports in the future. 293)

8.12.5.2.3 Altering schedules, networks or infrastructure

Regulation 1 (h) has the effect that it would be anti-competitive for the dominant carrier to “alter its schedules, networks, or infrastructure for the purpose of disciplining or eliminating a competitor or impeding or preventing a competitor's entry into, or expansion in, a market”. 294) The Competition Bureau did not regard changes in the dominant firm's network, schedule or infrastructure facilities in the normal course of business as necessarily or even usually anti-competitive. The Competition Bureau stated that it would be concerned about changes in the dominant carrier's network, schedule or infrastructure facilities for which “an anti-competitive purpose and effect had been identified and for which no valid business reason had been articulated”. 295)

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The Competition Bureau stated that in the event where a rival carrier negotiate an interline arrangement with the dominant carrier and the rival carrier required the feed traffic provided by the interline arrangement in order to make its service on a particular route profitable, on the basis that the dominant carrier's announced schedule by the rival carrier on which it scheduled its flights and began marketing its service on the route given, and the dominant carrier alter its schedule subsequent to the interline arrangement in a way that made the rival's service unprofitable (which change in schedule was not motivated by some valid business reason), the Competition Bureau would regard such action as an anti-competitive act as set out in regulation 1(h). 296)

8.12.5.3 Essential facilities and services

The new anti-competitive act added to section 78 (78(1)(k)) defined the denial by a person operating a “domestic service” (as defined in subsection 55(1) of the CTA) of access on reasonable commercial terms to facilities or services that are essential to the operation in a market of an “air service” or refusal by such a person to supply such facilities or services on such terms as a form of exclusionary conduct as an anti-competitive act. 297) In this regard, section 2 (1) of the airline regulations provide that for the purpose of section 78(1)(k) of the Competition Act, “facilities and services that are essential to the operation in a market of an air service”, 298) as defined in subsection 55(1) of the CTA, are those that: • Are required in order to provide a competitive air service. • Cannot reasonably or practicably be purchased, acquired, provided or replicated by another carrier on its own behalf. • Are effectively controlled by the air carrier who denies access to them or refuses supply of them, and • Can be feasibly provided to another air carrier, having regard to operational or safety considerations, or legitimate business justifications of the air carrier referred to in section (c). 299)

According to section 2 (2) of the airline regulations, facilities and services may include, but are not limited to, “take-off and landing slots, interline arrangements, airport gates, loading bridges, counters and related airport facilities, maintenance services, and baggage handling infrastructure, equipment and services”. 300)

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Raising a rival's costs could be the outcome of the anti-competitive act defined by section 78(1)(k), “the denial by a person operating a 'domestic service' . . . of access on reasonable commercial terms to facilities or services that are essential to the operation in a market of an 'air service' . . . or refusal by such a person to supply such facilities or services on such terms”. 301) This type of practice could lead to either an increase in a competing carrier's fixed costs or variable costs of operation. With respect to a possible impact on fixed costs, a situation could develop at a particular airport where a dominant carrier contracts for all or most of the available space within the terminal facility, including passenger service counters and gates. The carrier may be willing to sublease space to a rival carrier, but only at a lease rate that would either make the rival's operation unprofitable or inhibit the willingness of the rival to expand its service. 302)

A dominant carrier could also have agreements that give it exclusive access to certain airport services through third parties. As a result, a competing carrier's fixed costs could be raised relative to what they would have been in the absence of the third party agreements, assuming that the costs of the services do not vary with the number of passengers being carried. With respect to a possible impact on variable costs, the dominant carrier might have third party service agreements that grant it exclusive access to certain airport services that are necessary to offer an air service, but that are not available elsewhere in the market. A rival carrier would only be able to commence service by either purchasing third party services through the dominant carrier or providing the services for itself. If the prices the third party charged for these services, or the costs of providing services for itself are sufficiently high, the rival carrier could find it either unprofitable to serve the market at all or to expand its service. The exclusive third party service agreement, in conjunction with the refusal to make the service available on reasonable commercial terms, could constitute an anti-competitive act in Canada. 303)

In order for a carrier to be in possible contravention of 78(1)(k), the denial of access must be "on reasonable commercial terms" and it must be to facilities or services that are essential to the operation of an air service. The airline regulations contain four criteria that the Competition Bureau will use to determine whether a service or facility is essential to the operation in a market of an air service. They also contain a non-exhaustive list of facilities and services that may be essential. 304) The four criteria are set out below. Chapter 8 Page 933

8.12.5.3.1 Essential to provide service

First, the facility or service must be required in order for the air carrier to provide a competitive air service. As a result, it must not be possible to offer the competitive air service without the facility or service for which access is being denied. In every case of alleged denial of access, the Competition Bureau would examine whether the carrier being denied access could have arranged a substitute facility or service on reasonable terms. 305) As an example, in the case of a complaint that a carrier is denying access to interline arrangements on reasonable commercial terms, the Competition Bureau would consider whether the complainant could have provided a competitive air service in the market without the interline arrangement (e.g. with direct service). 306)

The inclusion of the phrase "competitive air service" meant, according to the Competition Bureau, that a carrier would not be able to defend its denial of access to an essential facility or service on the grounds that the facility or service is not required for the operation of an air service. The Competition Bureau stated that where passengers expect a carrier to provide a certain service, such as flights from airport A, and would not view a carrier as offering an acceptable substitute at an alternative airport B, then denial by the dominant firm of access to the airport A could imply the inability to operate a competitive air service. In addition, if the complainant carrier can only obtain access to the service on unreasonable commercial terms or at unreasonable times, then that could also imply the inability to operate a competitive air service. 307)

The phrase "competitive air service" was not intended to imply identical air service. Nor was the dominant carrier expected to subsidise the provision of an essential facility or service in order for an air carrier to provide a competitive air service. Such an expectation would contradict regulation 1(d), which refers to the feasibility of providing the facility or service, as well as 78(1)(k) itself, which refers to access on reasonable commercial terms. 308)

8.12.5.3.2 Cannot be reasonably replicated or acquired

The second requirement for a service or facility to be essential is that it “cannot reasonably or practicably be purchased, acquired, provided or replicated by another carrier on its own Chapter 8 Page 934 behalf”. 309) The Competition Bureau would seek to determine whether the service or facility for which access is being denied is available anywhere in the market on reasonable commercial terms. The Competition Bureau would also consider whether the complainant carrier could have provided the service or facility for itself on reasonable terms. For example, a carrier might complain that the dominant carrier is the only provider of baggage handling or maintenance services at a particular airport facility, and that these services cannot be reasonably purchased in the market. In the event of this type of complaint, the Competition Bureau would consider whether the complainant carrier could replicate baggage handling or maintenance services on reasonable terms. 310)

The ability to replicate a service could depend on who has effective control of the facility associated with the service. The Competition Bureau stated that if the dominant carrier has contracted for all available facilities at a given airport, a rival carrier might be unable to replicate or provide a service for itself at that airport. If the dominant carrier has contracts for all of the gate space at an airport, or the entire airport related baggage equipment (e.g. the baggage conveyor belts) then a rival carrier might be unable to offer air service from that airport. 311)

8.12.5.3.3 Controlled by a dominant carrier

The third requirement for a service or facility to be essential is that the air carrier refusing supply or access should “effectively control” it, “directly or indirectly”. 312) This requirement makes it clear that simply because the dominant carrier is using a particular facility or service does not imply that it has effective discretionary control over the service. 313)

8.12.5.3.4 Feasible to provide

The fourth requirement for a service or facility to be essential is that it can be “feasibly provided to another air carrier, having regard to operational or safety considerations, or legitimate business justifications of the air carrier denying access or refusing supply”. 314) In the case of an alleged refusal to supply an essential facility or service, the dominant carrier might be able to defend its refusal on valid business grounds. 315)

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The Competition Bureau suggested several examples of valid business reasons that might be offered for the refusal to supply. These grounds include the following: • The dominant carrier does not have sufficient capacity in place to meet its own requirements as well as those of the rival carrier which might require the dominant carrier to invest in new facilities, and it might be unreasonable to expect. • The dominant carrier could be required to cancel its own service in order to meet the rival's request for service, and such a requirement might be unreasonable. • Legitimate concerns regarding the safety procedures of a rival carrier. In this regard, the Competition Bureau would obtain the expertise of an independent third party to assess the validity of claims advanced by a dominant carrier that it is not feasible for it to provide access. 316)

8.12.5.3.5 Application of the essential facilities and services regulations

As with other acts in section 78, the denial of access on reasonable commercial terms to facilities or services that are essential to the operation in a market of an air service is only an abuse of dominance if the practice has had, is having or is likely to have the effect of preventing or substantially lessening competition in a market. 317)

The behaviour described by 78(1)(k) could also be challenged under section 79 of the Competition Act where the act involves an “airport authority that refuses to make available unused airport facilities or services for the operation of a competing carrier”. 318) A dominant air carrier in a market could attempt to contract with an airport authority to obtain exclusive access to the airport facility and services provided by the airport, paying a price higher than the airport authority would be able to obtain from a competing carrier. This could prevent the competing carrier's entry in a market as it would not be feasible for the competing carrier to construct its own airport facility. 319)

Over time, the various carriers serving the airport may have taken up all facilities at the airport. At some point, a new competing carrier may only be able to commence operations at the airport if: • The airport expands (which may not be under its control), or

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• The new competing carrier is able to obtain unused airport facilities, such as under- utilised gates, on reasonable commercial terms, from the carrier(s) or airport authority that controls them. 320)

Then a denial of access by the dominant carrier to essential facilities or services on reasonable commercial terms could be an anti-competitive act under section 78. 321)

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8.12.6 MARKETING CONDUCT OF AIRLINES

The regulations 1 (f) and (g), define two other anti-competitive acts as follows: • Regulation 1 (f), using commissions, incentives or other inducements to sell or purchase its flights for the purpose of disciplining or eliminating a competitor or impeding or preventing a competitor's entry into, or expansion in, a market. 322) • Regulation 1(g), using a loyalty marketing programme for the purpose of disciplining or eliminating a competitor or impeding or preventing a competitor's entry into, or expansion in, a market. 323)

TACOs and FFPs are instruments that can be used by airlines to build a loyal base of customers and travel agents. FFPs award points to travellers that can be redeemed later in the form of travel on other routes. Because the number of points the customer has with a specific airline depends on the amount of business the customer has given to that airline, the customer has an incentive to fly as much as possible with the same carrier. In addition, such FFPs will induce consumers to choose to fly on airlines with large networks that provide a larger number of routes on which the frequent flyer points can be redeemed. All of these features contribute to the ability of a FFP to induce loyalty from consumers. 324)

Similarly, airlines can use the structure of TACOs, and in particular commission overrides, to reward travel agents for booking flights with the airline. A typical commission override programme grants an increased commission to a travel agent provided that the agent books a specified percentage of its passengers on the carrier with which it has the agreement. This commission structure gives travel agents the incentive to book as many flights as possible on the same airline. 325)

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8.12.6.1 FFPs

An airline can potentially use a passenger loyalty programme such as FFPs to foreclose a potential or existing rival. In the event of new entry on a particular route the dominant airline could, as part of a campaign to eliminate the new rival, increase the frequent flyer awards on this route beyond what it would normally offer on similar routes on which it faces competition. This increase would have the same effect as lowering fares on the route; a package of greater value is being offered for the same price. If the increase is justified only because it eliminates or disciplines the new entrant, then it would be considered anti- competitive. 326)

8.12.6.2 TACOs

On the same basis TACOs can be used as an instrument to foreclose a potential or existing rival. In response to entry on a route, the dominant airline could increase the commission bonus earned by travel agents that book a large percentage of their passengers with the dominant carrier. Where the increase in bonus commissions is sufficient to induce agents to book flights of the offering carrier with the consequent effect of eliminating or disciplining a competitor, the Competition Bureau will consider the increased offering to be an anti- competitive act. 327)

8.12.6.3 Corporate Discount Programmes

Besides commission overrides that may be anti-competitive, regulation 1 (f) permits the Competition Bureau to challenge certain types of corporate discount programmes that might be anti-competitive. The Competition Bureau was of the opinion that it may be possible, for a dominant incumbent carrier to contract with firms, public institutions, or governments to be the preferred air carrier for their employees, offering discounts as inducements for such loyalty. Such contracts could be of concern if they cover a sufficiently large part of the market so as to have a material impact on competitive airline operations. These types of contracts could affect the ability of a rival carrier to attract sufficient passengers to make its operation profitable. They could also have an impact on a dominant carrier's ability to cover its avoidable costs. 328)

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The Competition Bureau anticipated that the manipulation of frequent flyer rewards, TACOs, and corporate discount programmes would most likely be anti-competitive when their manipulation is part of an overall anti-competitive strategy. Therefore, the Competition Bureau would consider whether loyalty programmes are being employed in order to contribute to or enhance the effects of other anti-competitive strategies listed in the regulations. However, the Competition Bureau did not rule out the possibility that the manipulation of FFPs and TACOs could be sufficient to achieve an anti-competitive aim. 329)

It should be noted that for the acts defined in regulations (f) and (g) to be anti-competitive, there must be evidence to indicate that the dominant carrier is engaging in them “for the purpose of disciplining or eliminating a competitor or impeding or preventing a competitor's entry into, or expansion in, a market”. 330)

The mere use of commissions, incentives, or other inducements to sell or purchase its flights, and the mere use of loyalty marketing programmes, are not in and of themselves considered anti-competitive acts under the airline regulations. 331)

The Competition Bureau stated that all the regulations with the exception of the first three regulations dealing with anti-competitive pricing, all of the other regulations require evidence of some anti-competitive purpose or object. In this regard, the Competition Bureau would note that the jurisprudence under section 79 has held that the element of anti-competitive intent or purpose can be established either with direct evidence or by inference based on the likely effect of a practice on competition in the particular circumstances of a case. 332)

8.12.7 OTHER ANTI-COMPETITIVE PRACTICES

In addition to the anti-competitive conduct defined for the airline industry by regulations, sections 78(1)(j) and (k), section 78 of the Canadian Competition Act provides a non- exhaustive, illustrative list of anti-competitive acts as follows: • Margin squeezing by a vertically integrated supplier against a customer-competitor. • Acquisition by a supplier of a customer to foreclose a competitor. • Freight equalisation on a competitor's plant to eliminate or impede competition.

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• Selective use of fighting brands to discipline or eliminate a competitor. • Pre-emption of scarce facilities or resources required by a competitor. • Buying up products to prevent price erosion. • Adopting incompatible specifications to prevent entry or eliminate a competitor. • Requiring or inducing suppliers to sell only or primarily to certain customers. • Selling articles below acquisition costs to discipline or eliminate a competitor. 333)

The abovementioned list of anti-competitive practices is discussed in more detail in a general Guidelines on Enforcement of “Abuse of Dominance Provisions” of the Competition Act, published by the Competition Bureau with respect to sections 78 and 79 on 1 August 2001. This general list of anti-competitive practices contained in section 78 could also apply to the airline industry. 334) 335)

8.12.8 SUBSTANTIAL PREVENTION OR LESSENING OF COMPE- TITION

In order to establish grounds for an order under section 79, the Competition Tribunal must be satisfied that the practice of anti-competitive acts is likely to result in a substantial prevention or lessening of competition (i.e. the third essential element in section 79). Anti-competitive acts involve actions that are either predatory, exclusionary or disciplinary in nature. The meaning of "lessening competition substantially" is established in case law in Canada. The question to be decided then is whether the anti-competitive acts engaged in by a firm or group of firms are likely to serve to preserve, entrench or enhance their market power by eliminating or disciplining a competitor or deterring entry into the market.

The Competition Bureau stated that its approach in assessing anti-competitive activities in the airline industry would focus on determining whether the activities are likely to have the following effects: • Raising rivals' costs or reducing rivals' revenues. • Foreclosing existing or potential rivals from essential services or facilities, and • Eliminating or disciplining competitors. 336)

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8.13 EVENTS SINCE RESTRUCTURING AND CONSOLIDATION IN THE CANADIAN AIRLINE INDUSTRY

It is important to consider the events that followed the restructuring and consolidation in the Canadian airline industry, in order to evaluate the subsequent conduct of the dominant airline and to gauge the relative success of the measures that were taken. The following sections will deal with the market conduct of Air Canada, the influence it had on smaller competitors, reports of the air travel complaints commissioner as well as the independent transition observer on airline restructuring and Cease and Desist Orders on Air Canada issued by the Competition Bureau. Such orders were challenged by Air Canada before the Competition Tribunal and resulted in an application of the Competition Bureau for an order against anti- competitive practices by Air Canada to the Competition Tribunal. A finding by the CTA that an Air Canada fare was too high on a monopoly route is also discussed. An address of the Commissioner of Competition on the State of Competition in the Canadian Domestic Airline Market is a fitting summary and conclusion to the very dramatic developments in the airline industry in Canada.

8.14 GENERAL FARE REDUCTIONS BY AIR CANADA

8.14.1 FARE REDUCTIONS BY AIR CANADA AND CAIL UP TO 40 PERCENT ON 22 MARCH 2000

On 22 March 2000, Canada's newly merged carriers, Air Canada and CAIL, announced that they had reduced fares by up to 40 percent on selected routes. The sale began on 22 March 2000 and continued until 4 April 2000, for travel beginning on 29 March 2000. 337)

8.14.2 FURTHER ANNOUNCEMENT OF REDUCTION OF FARES UP TO 40 PERCENT BY AIR CANADA AND CAIL - 25 OCTOBER 2000

Air Canada and CAIL announced a reduction of fares up to 40 percent across their network for the period of 25 October 2000 until 8 November 2000, for travel beginning from 1 November until 28 February 2001.

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"We are celebrating the customer service improvements resulting from the successful transfer to a single computer reservations system," said Air Canada Vice President Marketing, Danielle Poudrette. "The seat sale is our way of thanking our customers for their understanding leading up to this critical achievement". 338)

The abovementioned substantial reductions in fares as well as further targeted fare reductions by Air Canada will be shown to have had a negative effect on the financial results of Air Canada but also on smaller competitors. Among these Westjet and Canjet took decisive steps through the newly published regulations to prevent the negative effect of such action by Air Canada on them as well as action taken by the Competition Bureau and Competition Tribunal in order to protect competition, including the timing thereof.

8.15 COMPLAINTS BY WESTJET AND CANJET AIRLINES

8.15.1 INTRODUCTION

On 5 July 2000, Bill C-26 was enacted enabling the Canadian government to specify by regulation conduct that would constitute a practice of anti-competitive acts in the airline industry to enable enforcement of the abuse of dominance provisions of the Competition Act. The regulations were tabled before the Committee on 12 April 2000, were finalised and came into force on 23 August 2000.

Bill C-26 also empowered the Commissioner of Competition during the course of inquiries under the Act to issue temporary cease and desist orders. Temporary orders can only be issued under certain conditions to preserve competition before a case can be brought before the Competition Tribunal.

The first temporary order was issued against Air Canada in the CanJet investigation on 12 October 2000. The Commissioner of Competition stated that this extraordinary power that the Competition Bureau had, should be applied prudently and only when circumstances fully warrant it.

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The Competition Bureau did not receive any complaints relating to issues under the access to essential services and facilities provisions of the regulations. The key issue that emerged was predatory pricing. The Commissioner of Competition stated that is was difficult to distinguish between aggressive and legitimate competition and predatory conduct that may harm consumers over the longer run.

The Competition Bureau received nine significant complaints by smaller carriers against Air Canada of which, only two, WestJet and CanJet's, resulted in formal inquiries under the Competition Act. On 5 March 2001, the Competition Bureau filed an application before the Competition Tribunal encompassing the evidence obtained in both of these inquiries. 339)

The Bureau launched the first formal inquiry in June 2000, following a complaint from WestJet that Air Canada responded to its entry into the Atlantic Canada market by adding significant capacity and matching or undercutting WestJet's fares.

The second formal inquiry concerned CanJet's complaint that Air Canada abused its dominant market position in its pricing response to CanJet's entry in September 2000. On 12 October 2000 the Commissioner issued a temporary order against Air Canada, requiring it to withdraw certain discount fares on five routes in Eastern Canada. On 30 October 2000 the Commissioner extended the order for an additional 30 days, but limited its scope to three routes. 340)

As a result of information obtained from the WestJet and CanJet inquiries, the Commissioner filed an application before the Competition Tribunal on 5 March 2001, seeking an order: • Prohibiting Air Canada from operating or increasing capacity at fares that do not cover its avoidable cost of providing the service, and • Prohibiting Air Canada from engaging in a policy of matching fares offered by low- cost carriers under certain circumstances. The Tribunal hearing on the Bureau's application began on 27 August 2001 341) but the business was only partly completed on 22 July 2003 when the Competition Tribunal issued its reasons and findings. 342) This was almost two years after the original hearing commenced.

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A number of legal challenges were lodged by Air Canada against the Competition Bureau that included the following: • A challenge to the Commissioner's powers under section 11 of the Canadian Competition Act to subpoena information, and • Three challenges to the authority of the Commissioner of Competition to issue temporary orders under the new provision of section 104.1. • A challenge to the Commissioner's powers to issue temporary cease and desist orders. : 343)

The legal challenges by Air Canada in response to the formal inquiries of the Competition Bureau were initiated in order to suspend, set aside or vary the temporary cease and desist order and to circumvent the authority of the Commissioner of Competition. The legal challenges in Canada demonstrates that the dominant airline, Air Canada, did not accept the constraints imposed by legislation and eventually was successful in removing the authority of the Competition Commissioner to issue temporary cease and desist orders. These legal challenges were: • A motion filed on 12 October 2000 in Quebec Superior Court, sought a declaratory judgment to the effect that section 104.1 of the Competition Act, dealing with the Commissioner's authority to issue temporary orders, was unconstitutional. The hearing on Air Canada's motion took place in May 2001 and in July 2001 the Quebec Superior Court ruled in favour of the Commissioner's power to issue temporary orders under section 104.1 of the Competition Act. 344) • Another motion was filed by Air Canada on 19 October 2000 in the Quebec Superior Court that sought a suspension of the Commissioner's temporary order until resolution of the abovementioned constitutional challenge. On 24 October 2000 the Quebec Superior Court denied this request. 345) • An application to the Competition Tribunal of 2 November 2000 sought to have the temporary order of the Commissioner of Competition set aside or varied. On 24 November 2000 the Competition Tribunal upheld the Commissioner's order, extended it to 31 December 2000 and varied it by deleting reference to “similar fares” on the basis that this terminology was too vague. On 4 December 2000 Air Canada appealed this decision to the Federal Court of Appeal. 346) Judgment was delivered at Ottawa, Ontario, on 22 March 2002 in which the appeal of the decision

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of the Competition Tribunal pertaining to the interpretation of the Commissioner's statutory power to issue temporary orders and the Tribunal's role in reviewing them of 7 December 2000 was dismissed with costs. 347) 348) • Québec Court of Appeal did, however, repeal the Commissioner’s power to issue temporary cease and desist orders on 16 January 2003 in a constitutional challenge, based on the grounds that “section 104.1 of the Act was in violation of section 2(e) of the Canadian Bill of Rights, R.S.C. 1960, c. 44, which prohibits depriving a person of the right to a fair hearing in accordance with the principles of fundamental justice”. 349)

These challenges imply that the regulatory instruments that are used to promote competition should be clearly well drafted and implemented properly to withstand legal challenges from dominant operators, that will not necessary accept the “rules of the game” when they are introduced. Due consideration should however be had to the different functions of the institutions tasked with authority to enforce such rules.

8.15.2 TIME TAKEN IN DEALING WITH THE COMPLAINTS OF WESTJET AND CANJET AIRLINES

The chronology of events relating to the complaints by Westjet and Canjet Airlines has been summarised in a table, which is attached as annexure “AG”. From this table an overview can be obtained of the major events relating to the complaints that will be discussed in this section.

It is important to note that the original complaint of CanJet Airlines was lodged on 20 April 2000. On 5 March 2001 the Commissioner of Competition filed a notice of application pursuant to section 79 of the Competition Act, R.S.C. 1985, c. C-34 and the regulations Respecting Anti-Competitive Acts of Persons Operating a Domestic Service, SOR/2000-324 to the Competition Commission alleging abuse of dominant position by Air Canada.

It was alleged in the application that between the period of 1 April 2000 and 5 March 2001, Air Canada responded to the entry of WestJet Airlines Ltd and CanJet Airlines on seven central and Atlantic Canada routes by increasing its capacity and/or decreasing its fares, in a

Chapter 8 Page 946 manner that did not cover the avoidable cost of operating the flights on such affected routes, in violation of sections 1(a) and 1(b) of the airline regulations. 350)

The hearing of the first phase of the Air Canada abuse of Dominance Case was only concluded on 5 March 2003 before the Competition Tribunal. The Competition Tribunal released its findings and the reasons on 22 July 2003, which were ultimately in favour of WestJet and CanJet. 351) The time that elapsed from 20 April 2000 until 22 July 2003 demonstrates that the application of the normal competition process of adjudicating the matter exceeds the period for which the smaller airlines could probably sustain operations without sufficient support of enough traffic at reasonable yield, while this demand was being soaked up by the dominant airline market providing excess capacity at prices so low that they are insufficient to support operations (swamping).

During the intervening period, temporary intervention by the Commissioner of Competition in terms of a temporary cease and desist order, the original complainant, Canjet Airlines, ceased operations (as part of Canada 3000 in matters identified in 8.21 below), leaving only Westjet as an intervening party still in operation.

This clearly demonstrates that the process and procedures of conventional antitrust/competition intervention takes too long to be of real effective use in the airline industry. The mechanism of intervening by means of temporary cease and desist orders however appears to have pro-competitive benefits for the airline industry, as the Competition Commissioner can intervene to prevent predatory practices.

8.15.3 BACKGROUND TO THE COMPLAINT OF CANJET AIRLINES AND WESTJET AGAINST AIR CANADA

8.15.3.1 Introduction

The Canadian government implemented a number of regulatory instruments and institutional arrangements in order to foster competition and to provide measures for additional consumer protection. These measures were seen to be necessary in order to set off the effect of dominance in the market in that a dominant airline would be able to act independently of regard to its customers. Defining anti-competitive practices and the creation of powers to Chapter 8 Page 947 issue temporary cease and desist orders during the course of inquiries by the Competition authorities was applied in the case of entry by Canjet against Air Canada.

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8.15.3.2 Market entry by Canjet

In April 2000, the I.M.P. Group Limited ("IMP" a Canadian aerospace, general aviation, and flight management company based in Halifax, Nova Scotia) announced its intention to start CanJet Airlines ("CanJet") as a low-cost "no frills" domestic air service in Eastern Canada. On 31 July 2000, CanJet began to sell advance tickets for its initial flights, which were scheduled to start on 5 September 2000. CanJet entered the market offering one-way fares at prices that were substantially below Air Canada's full economy fares. CanJet commenced its flight operations on 5 September 2000, with two leased Boeing 737 aircraft. On 25 September 2000, CanJet leased another aircraft and offered service on three additional routes. 352)

8.15.3.3 Air Canada's response to the entry of Canjet

On 7 September 2000, two days after CanJet began to fly, it complained to the Commissioner about Air Canada's L14EASTS fares, which, had been offered for sale as of 1 September 2000 for flights commencing on 15 September 2000 by Air Canada. CanJet offered flights on a total of 14 routes but as a result of "inadequate bookings", CanJet decided, on 24 October 2000, to terminate all flights on its Ottawa/Windsor and Toronto/Windsor routes, effective on 26 November 2000. 353)

The airfares had two components: • The price of the ticket, and • The conditions related to its purchase.

The price of the L14EASTS fare of Air Canada matched the price of CanJet's announced fares. CanJet also introduced further reduced fares in response to the Lower Fares of Royal Airlines "Royal" (another low-cost/discount air carrier).

The fares of Air Canada and Canjet further differed in the following ways: • Certain fares were only available on selected flights. • There were some advance purchase requirements. • There were maximum and minimum stay requirements.

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• Some fares required a change fees. Although the L14EASTS fares were always more expensive and more restrictive than CanJet's Reduced Fares, only passengers who chose the L14EASTS fares earned Air Canada Aeroplan Points and received meal services. 354)

8.15.4 COMMISSIONER OF COMPETITION ISSUES TEMPORARY CEASE AND DESIST ORDER AGAINST AIR CANADA - 12 OCTOBER 2000

The Commissioner issued the Original Order pursuant to subsection 104.1(1) of the Act on 12 October 2000 with effect for 20 days pursuant to subsection 104.1(4) of the Act prohibiting Air Canada "from directly or indirectly offering or selling L14EASTS fares, or any similar fares", on five city-pair routes being: Halifax/Ottawa, Halifax/Montreal, Halifax/St. John's Toronto/Windsor, and Ottawa/Windsor referred to collectively as the "Five Restrained Routes" as well, the two routes serving Windsor will be described as the "Windsor Routes". 355)

The Commissioner considered that inter alia: • In the absence of the order, CanJet was “likely to be eliminated as a competitor on specific routes and suffer other harm that cannot be adequately remedied by the Tribunal”, and • Air Canada had engaged in conduct which could constitute anti-competitive acts in that Air Canada has reduced its fares to target CanJet on the five restrained routes. 356)

On 31 October 2000 the order was extended albeit for three routes Halifax/Ottawa, Halifax/Montreal, and Halifax/St. John's (the "Three Restrained Routes"). 357)

Based on preliminary information gathered, the Competition Bureau concluded that Air Canada's pricing response to Canjet's entry into the market could be anti-competitive and issued a temporary order requiring Air Canada to cease and desist from offering or selling special discount fares on five routes in Eastern Canada on 12 October 2000. 358)

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Commissioner of Competition, von Finckenstein K, stated that he issued the temporary order on the grounds that Canjet was “likely to be eliminated as a competitor on specific routes and suffer other harm that cannot be adequately remedied by the Competition Tribunal”, as investigations that nature were complex the order would give Competition Bureau “more time to assess the situation fairly”. 359)

The cease and desist order specified that, with immediate effect, Air Canada must stop offering or selling special L14EASTS fares on 5 routes in Eastern Canada. These routes were: Halifax-Ottawa, Halifax-St. John's, Halifax-Montréal, Toronto-Windsor, and Ottawa- Windsor. The Competition Bureau was satisfied that a temporary order was not warranted for two other routes, which are part of Canjet's complaint, namely, Halifax-Toronto and Toronto- Winnipeg. L14EASTS are special discount airfares offered on the five Air Canada routes, which require 14 days advance booking. 360)

The cease and desist order was effective for 20 days and would expire on 31 October 2000 but could be renewed twice for 30 day periods each. The purpose of the temporary order was to provide enough time for the Competition Bureau to decide if it will apply to the Competition Tribunal under the abuse of dominance provision (section 79) of the Competition Act. 361)

This was the first time the Commissioner issued a temporary cease and desist order. The Commissioner was given such powers through amendments to the Competition Act, passed by Parliament and put into force on 5 July 2000 and the Commissioner's authority to issue temporary cease and desist orders was exclusive to the airline industry. 362)

8.15.5 COMMISSIONER OF COMPETITION EXTENDS TEMPORARY ORDER ON 31 OCTOBER 2000

The Competition Bureau announced on 31 October 2000 that the Commissioner of Competition extended a temporary order that Air Canada was prohibited from directly or indirectly offering or selling special discount L14EASTS fares or any similar fares on the routes: • Halifax-Ottawa.

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• Halifax-Montreal. • Halifax-Saint John's.

The extended order had effect for 30 days from 1 November 2000. 363)

The extended order did not apply to the Toronto-Windsor and Ottawa-Windsor routes in the light of CanJet's decision to discontinue service on these routes.

The extended cease and desist order would expire on 30 November 2000 during which the Bureau's investigation would continue to determine whether there is sufficient evidence to proceed to the Competition Tribunal for an order prohibiting these fares under the abuse of dominance provisions (section 79) of the Competition Act.

As part of its investigation into this matter, the Competition Bureau obtained a court order requiring Air Canada to provide information necessary to the Bureau's inquiry by 15 November 2000. 364)

The temporary cease and desist order against Air Canada was extended and remained valid for 80 days (the maximum amount of time available to the Commissioner under section 104.1 of the Competition Act) and expired on 31 December 2000. 365)

8.15.6 AIR CANADA DROPS SOME OF ITS CUT-RATE FARES ON EASTERN ROUTES – 24 FEBRUARY 2001

As a result of action of the Canadian Federal Competition Bureau, Air Canada eliminated some of its cut-rate fares on eastern routes after a new competitor airline, Canjet, submitted a complaint to the Competition Bureau.

Air Canada announced on 23 February 2001 that it would withdraw its discounted one-way unrestricted economy fare with effect from 24 February 2001 on three routes - Halifax- Montreal, Halifax-Ottawa and Halifax-St. John's, Newfoundland "pending further clarification of the rules in the new competitive environment".

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The cease-and-desist order imposed by the Competition Bureau on other low fares expired on 31 December 2000 and according to Couture-Simard of Air Canada it elected not to re- introduce those rates until a final ruling by the Competition Bureau. Air Canada stated in a news release that its decision to reverse its fare cuts was valid pending further clarification of competition rules.

Air Canada chief executive Milton R, warned that the airline's growth will be "significantly curtailed" unless it takes action against its low-cost competitors like Calgary-based WestJet and CanJet and that it was "strategically important" that Air Canada launch its own no-frills airline to minimise the impact of the new discount competitors. He also warned that the Montreal-based carrier was facing similar pressure from new competitors in other parts of the country. 366)

8.15.7 CHALLENGE BY AIR CANADA OF THE TEMPORARY CEASE AND DESIST ORDER ISSUED BY THE COMMISSIONER OF COMPETITION TO THE COMPETITION TRIBUNAL ON 17 NOVEMBER 2000 - RULING ON 24 NOVEMBER 2000

Air Canada challenged the temporary order issued by the Commissioner of Competition to the Competition Tribunal on 17 November 2000, on which the Competition Tribunal latter ruled on 24 November 2000.

Simpson SJ granted an order on behalf of the Competition Tribunal on 24 November 2000, which confirmed the Temporary Order until 31 December 2000, but varied it to delete the phrase "any similar fares". 367)

8.15.8 THE NATURE OF THE TEMPORARY CEASE AND DESIST ORDER

8.15.8.1 Introduction

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The Commissioner of Competition was given exceptional powers to issue a temporary cease and desist order as part of several amendments to the Competition Act under Bill C-26. The legislation received Royal Assent on 29 June 2000 and came into force on 5 July 2000. The changes to the legislation and newly introduced airline regulations were made to enable the Competition Bureau to better protect competition in the airline industry and are part of the federal government's initiative to ensure that Canada's dominant airline carrier does not abuse its market position. The cease and desist powers applied specifically to the airline industry. 368)

8.15.8.2 The nature and purpose of the temporary cease and desist order

A cease and desist order is a temporary measure which can be applied to protect competition in the airline industry while the Competition Bureau continues with an investigation. The orders would specify what action the dominant airline carrier must take to comply with the law during the period of examination. 369)

8.15.8.3 Criteria for issuing cease and desist orders

A temporary cease and desist order can be issued when it is deemed necessary to immediately stop potential anti-competitive behaviour by the dominant carrier. The Competition Act envisaged two conditions that were required to exercise temporary cease and desist powers: • The Competition Bureau must have initiated a formal inquiry. An inquiry may be initiated either when the Commissioner has reason to believe there is a contravention of the Competition Act, or when the Commissioner receives a complaint under section 9 of the Competition Act. The purpose of a formal inquiry is to determine if there is sufficient evidence to apply to the Competition Tribunal under section 79 of the Competition Act, which relates to abuse of dominance. 370) • The Commissioner must have concluded that in the absence of a temporary order: o Injury to competition is likely to occur that cannot adequately be remedied by the Competition Tribunal, or o A person (airline) is likely to: Š Be eliminated as a competitor.

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Š Suffer a significant loss of market share. Š Suffer a significant loss of revenue, or Š Suffer other harm that cannot be adequately remedied by the Tribunal. 371)

A cease and desist order can be implemented for a period of 20 days. The order can be renewed twice, for 30 days each, if required, or revoked at any time. 372) The Commissioner is required to file the temporary cease and desist order with the Competition Tribunal. An air carrier, which is subject to an order, may apply to the Competition Tribunal to have the temporary order varied or set aside. The temporary cease and desist order will remain in force until the Competition Tribunal renders its decision. 373)

The purpose of the cease and desist order was to provide enough time for the Competition Bureau to decide if it will apply to the Competition Tribunal under the abuse of dominance provision (79) of the Competition Act. If the Competition Bureau did not have sufficient evidence for an application to the Tribunal, the case will be discontinued. 374)

8.15.8.4 The roles of the Competition Bureau and the Competition Tribunal

In order to distinguish between the respective roles of the Competition Bureau and the Competition Tribunal the following definitions are provided:

8.15.8.4.1 Competition Bureau

The Competition Bureau is an independent law enforcement agency whose mandate is to maintain and encourage fair competition in Canada. 375)

8.15.8.4.2 The Competition Tribunal

The Competition Tribunal is a specialised court that hears and decides applications made under the civil provisions of the Competition Act. The Competition Tribunal is an adjudicative body that operates independently of any government department.

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The Competition Tribunal is composed of not more than four judicial members and not more than eight lay members. The judicial members are appointed from among the judges of the Federal Court, Trial Division. Lay members are appointed by the Governor in Council on the recommendation of the Minister of Industry. 376)

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8.15.9 APPLICATION TO PROHIBIT AIR CANADA FROM OPERATING FLIGHTS BELOW AVOIDABLE COSTS UNDER THE ABUSE OF DOMINANCE PROVISIONS OF THE COMPETITION ACT

8.15.9.1 The Air Canada abuse of Dominance Case

As noted in 8.15.8.3 above, one of the conditions for issuing a cease and desist order is that the Competition Bureau must have initiated a formal inquiry of which the purpose is to determine if there is sufficient evidence to apply to the Competition Tribunal under section 79 of the Canadian Competition Act, which relates to abuse of dominance. As such, the formal application to prohibit Air Canada from operating flights below avoidable costs under the abuse of dominance provisions of the Competition Act was the second step in the process in the proceedings of the abuse of dominance case against air Canada.

An application to the Competition Tribunal by the Competition Bureau for an order prohibiting Air Canada from operating flights below avoidable costs under the abuse of dominance provisions of the Competition Act was launched, as dealt with in more detail in annexure “AH”.

The Commissioner of Competition and Air Canada proposed that the Application would be discussed in two phases, which was accepted by the Competition Tribunal. The purpose of Phase I of the Application was to obtain a decision from the Competition Tribunal respecting the proper approach to the avoidable cost test which is contained in the airline regulations 377) (Regulations Respecting Anti-Competitive Acts of Persons operating a Domestic Service (“airline regulations”), SOR 2000-324, sections 1(a) and (b)).

The four questions that needed to be established by the Competition Tribunal in establishing whether Air Canada operated flights below avoidable costs with regard to the avoidable cost test were: 378) • What is the appropriate unit or units of capacity to examine? • What is the appropriate time period or periods to examine? • What categories of costs are avoidable and when do they become avoidable? • What, if any, recognition should be given to “beyond contribution”? 379)

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In addition to the four questions, the Competition Tribunal was required to indicate whether Air Canada operated or increased capacity on its Toronto-Moncton and Halifax-Montreal routes at fares below avoidable cost. 380)

The Montreal-based airline, Air Canada, was accused of abusing its dominance with cut-rate fares in Eastern Canada, where it faced competition from WestJet and from CanJet. According to the Competition Bureau, before WestJet launched service on its Hamilton- Moncton route, Air Canada's top one-way fare for Toronto-Moncton was C$605. After WestJet began selling tickets at prices from C$129 to C$339, Air Canada responded by adding 55 percent more capacity and offering one-way fares from C$129 to C$249. 381)

8.15.9.2 Avoidable costs

The Competition Law in Canada prevents a dominant airline from pricing below its avoidable costs (being costs that could be avoided if the airline were not to operate certain flights). Air Canada and the Competition Bureau proposed very different definitions of avoidable costs. Air Canada proposed a formula that counted more revenue and fewer costs than the Competition Bureau proposed.

The Competition Bureau, which prosecutes competition cases at the tribunal, did not dispute that nearly half of Air Canada's flights would be illegal under the definition it was proposing. But the Competition Bureau stated it would only apply the test in situations where a dominant carrier responds to a smaller competitor by lowering fares, adding capacity, or selling more seats at lower fares.

The Competition Bureau stated in its closing arguments that the Commissioner of Competition did not seek to apply the avoidable cost test to the ongoing ordinary operations of a dominant airline, nor did it apply if a dominant carrier does not respond to the competitor, even if the result is operating below avoidable cost. 382)

The findings of the Competition Tribunal with regard to what comprise avoidable cost are set out in annexure “AI”. It is important to note that with regard to aircraft ownership cost the Competition Tribunal found that the market value based approach was superior to the Chapter 8 Page 958 accounting-based approach that Air Canada had itself rejected. 383) The price at which an airline could dispose of the aircraft or the price at which the aircraft could be leased out was an avoidable cost because it represented the fair market value of the aircraft. 384)

The Competition Tribunal stated that the evidence clearly supported the use of a market value based approach to aircraft ownership costs in the avoidable cost test. The correct figure for an avoidable cost test was regarded as the current market-value lease rate. 385) Aircraft ownership costs could be avoided by disposal, sublease, and return to a lessor, which indicated to the Competition Tribunal that such costs could be avoided in several ways. 386)

8.15.9.3 Intent

The lawyers for the Competition Bureau submitted internal reports from Air Canada as evidence: • One report, prepared for the company's board of directors by a consultant, stated that Air Canada was able to "drive out" several low-cost competitors through the 1990s. At hearings before the Competition Tribunal, Air Canada executives, however, stated that the actions taken by the airline differed from what was stated in the consultant's report. 387) • Another internal Air Canada document stated that CAIL was the only airline in a position to take the “brutal action” required to halt WestJet's development. It noted that while the airline matched WestJet's fares, it gave WestJet room to grow by failing to “add enough capacity to soak up the demand created by the low prices”. 388)

8.15.10 BANKRUPTCY PROTECTION FOR AIR CANADA UNDER THE COMPANIES' CREDITORS ARRANGEMENT ACT (CCAA)

The grant of bankruptcy protection to Air Canada intervened in the consequences of the proceedings with regard to the application under section 79 of the Canadian Competition Act, before the Competition Tribunal to prohibit Air Canada from operating flights below avoidable costs in terms of the abuse of dominance provisions of the Competition Act.

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Air Canada was granted protection from its creditors by the Ontario Superior Court of Justice, in a filing for bankruptcy protection on 1 April 2003. Air Canada had lined up US $700 million in special financing to help it operating while it restructured. With Companies' Creditors Arrangement Act (CCAA) protection in place, all creditors are prevented from taking any action against the airline. 389)

The bankruptcy filing of Air Canada came as the airline faced “major debt repayment deadlines and dwindling cash reserves”, which analysts thought could run out in about three months. Air Canada struggled with almost C$13 billion in debt, part of which it acquired in its successful 1999 takeover of CAIL as well as troubles that emanated as a result of the economic downturn in 2000 and 2001 that reduced its lucrative business travel. This was followed by the US attacks of 11 September 2001, which devastated airline business around the world. 390)

Air Canada attempted to fend off competition from discount upstarts like WestJet and CanJet. A series of price wars damaged its profitability as it fought for market share with rivals that had much lower labour costs. High fuel prices as well as the 2003 war in Iraq further cut back on passenger traffic. Air Canada also cited the Iraq war as one of the reasons why it was cutting 3,600 of its 35,000 jobs on 20 March 2003. Those cuts were on top of C$650 million it wanted to slash from its annual labour bill. 391)

The Ontario Superior Court (Justice Farley J) inter alia ordered a stay and suspension of all proceedings against Air Canada on 1 April 2003 and in particular requested the aid and recognition of any court or any judicial regulatory administrative body or the Federal Court of Canada any judicial regulatory administrative tribunal or other court pursuant to the Parliament of Canada. 392)

The Competition Tribunal concluded its hearing on 5 March 2003 (almost two years following the initial launch of the proceedings of the application to prohibit Air Canada from operating flights below avoidable costs under the abuse of dominance provisions of the Competition Act) and was in the process of deliberating in order to render its reasons and order when it was informed of the initial bankruptcy protection order of Air Canada (ONSC 03-CL-4932) by Justice Farley J of the Ontario Superior Court of Justice. Justice Farley J ordered (in section 70 of the Order), “the aid and recognition” of the Competition Tribunal, Chapter 8 Page 960 among others, to act in aid of and to be complementary to the Ontario Superior Court of Justice bankruptcy protection order. 393)

On 15 April 2003 a conference call took place between Houston DB Osborne WMG and Pratt JL of the Commissioner of Competition, Kay KL for the respondent Air Canada and McDonald DJ for the intervener WestJet Airlines Ltd and Justice Farley J, during which Justice Farley J heard oral comments relating to the effect of the bankruptcy protection order on the proceedings before the Competition Tribunal. The Competition Tribunal established that the bankruptcy protection order of Justice Farley J was not binding on the Tribunal, the Competition Tribunal, however, agreed with the spirit of the order and decided that it was in the interest of justice not to release the Tribunal’s reasons and order at that time. 394) The Competition Tribunal ordered on 16 April 2003 that: • The members of the Competition Tribunal had to complete their deliberations on the reasons and order in the case. 395) • The Competition Tribunal would consider whether it was appropriate to release the reasons and order when they were ready in the spirit of the bankruptcy protection order of Justice Farley J. 396)

8.15.11 REASONS AND FINDINGS OF THE COMPETITION TRIBUNAL - 22 JULY 2003

On 15 May 2001, at the request of both the Commissioner and Air Canada, the Competition Tribunal (the “Tribunal”) ordered that the application of the Commissioner of Competition be heard in two phases: • Phase I, to deal with the application of the avoidable cost test to two sample routes, from the period of 1 April 2000 to 5 March 2001, and • Phase II, to deal with the balance of the application. 397)

The Competition Tribunal considered two issues and four questions during the Phase I Period of the proceedings.

The following issues were heard and determined before proceeding with the balance of the application:

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• Did Air Canada operate or increase capacity at fares that do not cover the avoidable costs of providing the service, within the meaning of sections 1(a) and 1(b) of the regulations respecting anti-competitive acts of persons operating a domestic service (the “airline regulations”), SOR/2000-324, on the Toronto-Moncton/Moncton- Toronto route between the period from 1 April 2000, to the date of the application. 398) • Did Air Canada operate or increase capacity at fares that do not cover the avoidable costs of providing the service, within the meaning of sections 1(a) and 1(b) of the airline regulations, on the Halifax-Montreal/Montreal-Halifax route between the period from 1 July 2000, to the date of the application. 399)

The four questions that were resolved by the Competition Tribunal on 22 July 2003 for the purpose of conducting the avoidable cost test pursuant to the airline regulations, were: • The appropriate unit or units of capacity is the scheduled flight. • Cost items that were avoidable due to their variable-cost characteristics and costs identified as overhead were unavoidable. The avoidable costs were regarded as avoidable from the outset by virtue of shedding, redeployment or disposal. • The appropriate time period or periods to examine is a month. 400) • No recognition should be given to “beyond contribution”. 401) Beyond contribution was an attempt of Air Canada to measure the importance to the initial flight leg of carrying connecting or through passengers from a city to other destinations within the network. Air Canada calculated this by taking the amount of a continuing passenger’s fare that is prorated to the connecting leg (the beyond revenue) and subtracting a measure of cost for carrying the passenger on the connecting leg (the beyond cost). 402)

Based on these findings, the Competition Tribunal found that in the period from 1 April 2000 to 5 March 2001 (the date of the application), Air Canada operated or increased capacity at fares that did not cover the avoidable costs of providing the service on the Toronto- Moncton/Moncton-Toronto route. 403) The Competition Tribunal also found that in the period from 1 July 2000 to 5 March 2001 (the date of the application), Air Canada operated or increased capacity at fares that did not cover the avoidable costs of providing the service on the Halifax-Montreal/Montreal-Halifax route. 404)

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It is important to note that, although the Competition Tribunal concluded that Air Canada failed the avoidable cost test, it did not automatically lead to a conclusion that Air Canada had engaged in an abuse of dominant position under section 79 of the Act. A practice of anti- competitive acts, among other elements, had to be demonstrated under that provision. 405) 8.15.12 CONCLUSION: THE IMPORTANCE OF TEMPORARY CEASE AND DESIST ORDERS

It is evident that final adjudication of this matter would play an important role in the clarification of the concept of avoidable costs and the definition and evaluation of predatory practices in the airline industry. As a result, it is essential that the findings, order and reasons therefor be published by the Competition Tribunal in Canada, not only in order to adopt similar regulations, but because the various arguments that were raised by the parties in the Air Canada abuse of dominance case could be considered as a measure of precedence, and could also lead to changes in the wording of regulatory instruments. As demonstrated above, even with acceptable definition of the concept of avoidable costs and the definition and evaluation of predatory practices in the airline industry, the process and procedures of conventional antitrust/competition intervention takes too long to be of real practical immediate use in the airline industry. This can be mitigated by a mechanism providing a quick intervention for the Competition Commissioner by means of temporary cease and desist orders more timeously to prevent further damage as a result of predatory practices.

8.16 COMPLAINT FILED BY ROOTS AIR WITH THE FEDERAL COMPETITION BUREAU - 8 MARCH 2001

On 8 March 2001 Roots Air filed a complaint with the Federal Competition Bureau accusing Canada's dominant airline of predatory pricing on two major routes that Roots Air planned to start operating in March 2001. The new discount carrier requested the Competition Commissioner to hold an inquiry and order new fare schedules for Toronto-Calgary and Toronto-Vancouver flights.

Air Canada's new three-day advance fare between Toronto and Calgary was dropped to C$909 while the fare to Edmonton, where Roots Air won't be flying, remained at C$1,903. In Chapter 8 Page 963 addition, the three-day C$999 advance fare for Toronto-Vancouver compares with C$1,388 for Winnipeg-Vancouver. Shetzen T, Roots Air's executive vice-president and chief commercial officer was quoted as saying that "There is no other imaginable reason for dropping these fares other than to deliberately strike at a new, service-oriented player that's a real threat to their market dominance”. Roots Air, operated by Skyservice Airlines, also accused Air Canada of stalling tactics on granting Roots Air passengers access to Aeroplan frequent flyer points.

Responding to the complaint about fares, Calin Rovinescu, an Air Canada executive vice- president, stated in a press release that “ The notion that Air Canada is engaging in predatory behaviour by offering an economy fare with restrictive conditions between Toronto and Vancouver at C$999 defies common sense - this type of posturing cannot be taken seriously".

The CTA stated on 7 March 2001 that the lowest return fare - about C$400 - offered by Air Canada in early August on its service between Prince Rupert, B.C. and Vancouver was about double the ticket price on a route of similar distance. The CTA ordered Air Canada to cut the fare. Air Canada however stated that a price cut would undercut the fares offered by a competing airline, which contradicted the position taken earlier by the Competition Bureau. 406)

8.17 AIR CANADA INCREASES FARES OWING TO COST PRESSURE

Milton R of Air Canada stated on 6 February 2001 that fares will continue to increase owing to perpetual pressure on costs in every aspect of the economy, which also applied to Air Canada. According to him, it made sense that Air Canada fares go up "in lock step" with the US airline industry as it was “a good place to look to in terms of how we go for our prices”. This followed an announcement five weeks previously in which Air Canada raised its domestic fares by six percent. The carrier had promised to keep fares down while the carrier merged with Canadian Airlines, which period expired on 1 January 2001. During the merger period, the airline faced a fuel price increase that sparked many of its US counterparts to add fuel surtax to the price of their fares.

This followed the release of disappointing fourth quarter results of an operating loss of Chapter 8 Page 964

C$394 million in the fourth quarter of 2000, C$245 million before the estimated one-time items associated with its merger with Canadian Airlines. According to Milton R, the escalating fuel prices more than cancelled out the financial synergies of merging the two carriers in 2000. Air Canada also planned to reduce its workforce by about 3,500 jobs through attrition, an employee buyout and “other measures”. 407) 8.18 FINDING BY CANADIAN TRANSPORTATION AGENCY THAT A FARE OF AIR CANADA FARE WAS TOO HIGH ON MONOPOLY ROUTE - 7 MARCH 2001

8.18.1 INTRODUCTION

Following the Air Canada Canadian Airlines merger, the new Air Canada adopted different strategies relating to routes where competition developed and other routes where it maintained an effective monopoly. In the latter case, Air Canada effectively increased its fares to such an extent that it offered a yield that appeared to be excessive to consumers. Provision was made for authority in these circumstances (of excessively high fares) for the CTA to intervene, while the Competition Commission would intervene in cases where competition was threatened by excessively low fares.

The effect of this intervention is to limit the ability of a dominant airline to act independently of its customers by charging excessively high fares on routes where there is not any competition (in order to effectively contribute to cross subsidisation of those routes where there are competition and fares are reduced on competitive grounds). This is an important tool that should exist in cases where a dominant network airline exists that has a mixture of routes where it competes and other routes where it has no competition.

In its Policy Framework for Airline Restructuring in Canada the government of Canada stated that it would not tolerate price gouging and subsequently reviewed section 66 of the CTA, which allows the CTA to act on complaints regarding basic fares on monopoly routes. In addition to his statement that the government of Canada “will not tolerate price gouging," the Minister of Transport Collenette added that "Clearly, the best guarantee for reasonable air fares is viable competition. The government introduced measures for dealing with pricing and predatory behaviour in legislation” after taking into consideration the views on pricing provided by the House and Senate Standing Transport Committees. The government of Chapter 8 Page 965

Canada considered a “full range of options to ensure that it has the power to deal effectively with any potential price gouging, including effective monitoring powers and sanctions, as necessary".

It became necessary to exercise these powers to limit fares published or offered by Air Canada in respect of its monopoly domestic service between Prince Rupert and Vancouver on or about 10 August 2000, that was found to be unreasonably high.

8.18.2 THE CANADIAN TRANSPORTATION AGENCY DEEMS AN AIR- FARE CHARGED BY AIR CANADA TO BE UNREASONABLY HIGH

In the abovementioned sections it was established that Air Canada charged fares that were below its avoidable cost levels on routes where low cost competition developed. This section deals with the converse, that Air Canada charged excessively high tariffs on routes where no competition existed. This possibility was foreseen at the time that CAIL and Air Canada merged.

On 7 March 2001 the CTA rendered a decision that the lowest return fare offered by Air Canada on its service between Prince Rupert and Vancouver on or about 10 August 2000 was unreasonably high when compared to the lowest return fare on a comparable competitive route. 408)

The CTA found that: • Air Canada was the only air carrier providing a domestic service between Prince Rupert and Vancouver, and that Air Canada's service between Winnipeg and Saskatoon, a route on which there is competition, is a similar service. 409) • The CTA then determined that the significant difference in the lowest round trip fares on these two routes was not justified by the minor differences in the restrictions that apply to them. 410)

As a result, the CTA directed Air Canada to amend its tariff by reducing its lowest round trip fare on its service between Prince Rupert and Vancouver to make it comparable to the lowest fare offered on its service between Winnipeg and Saskatoon. Air Canada will be required to Chapter 8 Page 966 apply this fare for the same duration and in the same proportion regarding seat availability as it offers the fares for the Winnipeg-Saskatoon service. 411)

The decision resulted from a complaint about fares on a non-competitive route since changes to the CTA came into force on 5 July 2000 which empowered the CTA to determine, upon complaint, the reasonableness of passenger fares and cargo rates on routes within Canada where there is no, or only limited, competition. The intent of the provisions of the Act was to ensure that travellers on "non-competitive" routes are offered fares that are broadly comparable in level and range to those offered to travellers on "competitive" routes. 412)

The CTA is an independent quasi-judicial tribunal whose procedures are governed by the rules of natural justice, which ensure that all parties receive fair and equitable treatment. 413)

8.18.3 PROCESS TO MAKE RELATIVE COMPARISONS OF FARES

A single affected individual brought a complaint and the CTA found that: 414) • The air carrier who published or offered the fare which is the subject of the complaint is a licensee who, including affiliated licensees, is “the only person providing a domestic service between two points”, and 415) • The fare offered or published by the licensee in respect of the service is unreasonable. 416)

The CTAs jurisdiction over complaints concerning fares may be extended to domestic routes served by more than one licensee where the CTA is of the opinion that none of the other services between those two points provides a reasonable alternative "taking into consideration the number of stops, the number of seats offered, the frequency of service, the flight connections and the total travel time". 417)

When determining whether a fare published or offered in respect of a domestic service between two points is unreasonable, the CTA had to consider the following factors in terms of subsection 66(3). 418) • Historical data respecting fares applicable to domestic services between the two points.

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• Fares applicable to similar domestic services offered by the licensee and one or more other licensees using similar aircraft, including terms and conditions of carriage and the number of seats available at those fares. • Any other information that may be provided by the licensee. In determining whether a particular service between two points is "similar" to the service that is the subject of a section 66 complaint within the meaning of section 66(3)(b) of the CTA, the CTA considered the following factors: • Whether there are other licensees offering a domestic service between the two points. • The type of aircraft used by the licensee, which is the subject of the section 66 complaint to operate its service between the two points. • The air mileage between the two points, and • The origin-destination passenger volume between the two points. 419)

The determination of similarity of fares on domestic services included considerations relating to being: • More restrictive. • Minimum stay requirements. • The difference in both the amount of discount for unrestricted round-trip economy fare and the revenue per mile in comparison to minor differences in the terms and conditions of carriage applicable.

8.18.4 SUMMARY AND IMPLICATIONS OF THE INTERVENTION BY THE CANADIAN TRANSPORTATION AGENCY

A process of handling situations where fares may be established at a too high a level on monopoly routes (from a consumer perspective) was established in Canada. The effect of this intervention is to limit the ability of a dominant airline to act independent of its customers (that are directly affected) by charging too high fares on routes where there is not any competition (in order to effectively contribute to cross subsidisation of those routes where there is competition and fares are reduced on competitive grounds). This is an important tool that should exist in cases where a dominant network airline exists that has a mixture of routes where it competes and other routes where it has no competition, unless the dominant carrier is suitably restructured and exposed to competition.

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8.19 EVALUATION OF THE EFFECT OF THE STEPS TAKEN IN CANADA

8.19.1 INTRODUCTION

On 8 May 2001 Von Finckenstein K, the Commissioner of Competition of the CCB, addressed the House of Commons SCOT and on government operations on competition in the Canadian Airline Industry on three key issues relating to: • The desirability of allowing greater foreign participation in the domestic airline market which had changed in the light of recent developments in the industry. • The extent to which the undertakings made by Air Canada in negotiations with the Competition Bureau have been effective in reducing barriers to entry and facilitating competition in the domestic airline market. • The Bureau's experience to date with the airline industry amendments to the Competition Act, the related regulations defining anti-competitive practices and powers to issue temporary cease and desist orders during the course of inquiries. 420)

In addition, this section deals with the development and demise of local competition that developed as a response to the measures that were taken to foster competition in the Canadian domestic airline market, the work of the CTA Review Panel, the effect of the US terrorist attacks of 11 September 2001 on airlines in Canada and the latest proposals to increase competition through foreign sources and the revision of competition act following the collapse of Canada 3000.

8.19.2 THE STATE OF COMPETITION IN THE CANADIAN DOMESTIC AIRLINE MARKET

The Commissioner of Competition stated that the failure and subsequent acquisition of Canadian Airlines by Air Canada dramatically reduced the level of competition in domestic airline markets. 421)

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Since the time of the merger of Canadian Airlines and Air Canada, the following developments affecting competition in the domestic market took place: • WestJet expanded eastward. CanJet entered the market in eastern Canada and Royal expanded its scheduled services. • Skyservice Airlines, through Roots, sought to carve out a niche in the business market between Toronto and western Canada. • However, both Royal and CanJet were acquired by a new airline, Canada 3000. • Roots Airline commenced operations after about only six weeks and suspended service 4 May 2001 pending a strategic partnership (which the Commissioner of Competition considered as a merger under the Competition Act) with Air Canada to launch a low-cost service Skyservice. 422)

Some competitive alternatives developed, but were only to a limited degree with WestJet and Canada 3000. This competition was largely confined to major urban centres and primarily for the leisure or the time insensitive sector of the business market. Even with the growth of Canada 3000 and WestJet, Air Canada is 13 times larger than its next competitor in terms of domestic passenger revenues. The Commissioner of Competition stated that Air Canada had virtually no effective competition for business travellers and most local and regional markets remain monopolies. 423)

The inability of Canjet, Royal and Roots to operate profitably suggested to the Commissioner of Competition that whilst entry into the scheduled domestic market may be possible, there were serious doubts about the ability of such firms to remain as sustainable competitors in the face of Air Canada's dominance. 424)

The Commissioner of Competition was of the view that the need for significant legislative and regulatory changes to promote competition in the airline industry remained strong. 425)

Westjet adopted a more focused business plan of internal organic growth whilst Canada 3000 adopted a business plan of takeovers and mergers with smaller airlines. In the aftermath of a general decline of business volumes following the terrorist attacks on the USA, Canada 3000 was liquidated. Some background on the developments relating to Canada 3000 is set out in section 8.21 below.

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8.20 STATE AID FOLLOWING THE TERRORIST ATTACTS OF 11 SEPTEMBER 2001 ON AIRLINES IN CANADA

8.20.1 INTRODUCTION

According to Graves G and Saccoccio S, the airline business took a nosedive following the terrorist attacks on the USA of 11 September 2001. Immediately after the attacks, air travel plummeted and airlines were losing millions of dollars in the first days following the attacks with some recovery in October 2001, but the number of passengers carried was still substantially lower than in October 2000. 426)

8.20.2 THE EFFECT OF THE TERRORIST ATTACKS ON AIR CANADA

Air Canada CEO Milton R stated that the aftermath of the attacks led to a major downturn in business, especially in its international business, which normally generated more than 50 percent of its revenues. Air Canada informed a further 5,000 of its workers that their employment at the airline had come to an end. Air Canada would also ground 84 aircraft in its fleet and further reduce its flight schedule following the events of 11 September 2001, which left it "little choice".

Air Canada stated it would mothball 55 aircraft from its main fleet and 29 from its regional fleet. Twenty of its Boeing 737s would be transferred to the airline's new discount carrier when it started up in November 2001. Air Canada stated that the new discount airline could absorb some of the job losses at its mainline carrier and the regional carrier, but gave no specifics. About 4,000 of the job cuts will take place at the main carrier; another 1,000 jobs to be cut at its regional carrier. The job cuts totalled 12,500 at Air Canada. The cuts were in addition to 4,000 job cuts announced in early August and the elimination of 3,500 jobs in late 2000. Unions expected the cuts in the aftermath of the fall-off in post-attack travel. 427)

Air Canada expressed its appreciation of the Minister's response in providing partial compensation to the industry for losses incurred due to the closure of Canadian airspace following the tragic events of 11 September 2001 in the USA. 428)

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At the same time Air Canada announced that it would continue to take all action necessary to stabilise its operation and sustain the airline during this period of unprecedented crisis in the global airline industry. In this regard, Air Canada announced that it would reduce its system- wide flight schedule by 20 percent, remove 84 aircraft from its fleet and proceed with 9,000 job reductions, but that Air Canada would be reactivating its pre-September 11 Action Plan to re-engineer the airline in order to meet changing consumer demands consistent with the new realities in a post-September 11 environment. This referred to the launch of a low cost airline “Tango”. 429)

The linkage of the compensation paid to Air Canada to a resumption of Tango was criticised as will be evident from section 8.21 below.

8.20.3 INDIVIDUAL OWNERSHIP RESTRICTIONS ON AIR CANADA

Transport minister David Collenette informed the House of Commons that the Canadian government would scrap the restriction that existed at that time that prevented an individual Canadian investor from owning more than 15 percent of the airline's shares. The 25 percent limit on individual foreign ownership would, however, not be changed. 430)

Air Canada wanted the foreign ownership restriction increased from 25 percent to 49 percent. 431)

8.20.4 STATE FINANCIAL AID TO CANADIAN AIRLINES AND ACTION TAKEN BY CANADIAN AIRLINES

According to McFeat T, it was clear that airlines would be the corporate sector that would face the worst fallout in the aftermath of the 11 September 2001 attacks. Air travel would face new restrictions, and the public was (in the short term) much more reluctant to board aircraft. McFeat T made the following observations relating to the aftermath of the 11 September 2001 attacks. 432)

All commercial jet traffic in North America was grounded in the days following the attacks and when the airlines finally resumed flying, carriers found many of their planes were flying with just a handful of passengers. Chapter 8 Page 973

Airlines around the world began appealing for government aid. The US airline industry initially requested US $24 billion in help but later scaled that back to $17.5 billion US. On the basis that up to half the US carriers faced bankruptcy within 90 days, Washington quickly approved US $15 billion worth of aid ($5 billion US Dollars in cash and $10 billion US Dollars in loan guarantees). Air Canada estimated it lost C$100 million in the few days its fleet was grounded and when it resumed flying, Air Canada president Robert Milton estimated that revenues were 60 percent lower than the previous year. McFeat T estimated the debt of Air Canada at that time to be more than C$10 billion.

Air Canada requested C$4 billion in government assistance, later revising that to C$2 billion. But the Canadian government "balked at the size of that request” and competitor WestJet accused Air Canada of trying to get Canadian taxpayers to solve financial problems that began long before the 11 September 2001. 433)

Early November 2001, Canada 3000 tried to cut more than a thousand jobs and sought creditor protection, on the basis that the effects of 11 September 2001 made a bad situation even worse. It eventually grounded all its flights and filed for bankruptcy on 11 November 2001, leaving 4,800 employees out of work.

Transat AT, parent company of Canadian charter carrier Air Transat, cut 1,300 jobs.

On 2 October 2001 the Canadian government finally announced the first phase of its aid package. Air Canada would get the lion's share of it, but the initial package fell far short of what it requested. Air Canada got C$100 million of the C$160 million in emergency aid for the industry.

The Canadian government stated that the money was meant only to cover losses incurred from the forced grounding of aircraft. Further restructuring of the industry in general (and Air Canada in particular) would be required before any more financial assistance would be forthcoming. 434)

It does not appear as if any conditions were set for the state financial aid similar to those set by the EC on airlines in the same situation. In this regard, the criticism relating to the

Chapter 8 Page 974 financial aid provided to Air Canada in relation to its actions relating to pouncing a low priced airline, Tango in opposition to Canada 3000 should be noted.

8.21 “TANGO” BY AIR CANADA AND THE DEMISE OF CANADA 3000

Canada 3000 started up as a charter service in 1988 and became one of Canada's largest vacation providers though its subsidiary, Canada 3000 Holidays. Following a public offering in July 2000, Canada 3000 became Canada's second-largest airline with the acquisition of Royal Aviation and CanJet early in 2001. By the Canadian summer of 2001 it had almost 5,000 employees and about 5 million passengers a year with fleet of more than 40 aircraft. 435)

Air Canada's no-frills service Tango was launched on 1 November 2001. Tango essentially matched Canada 3000's prices on all of its principal routes. The chief executive officer of Canada 3000 claimed that the purpose of the launch of Air Canada’s “Tango” airline was to drive competitors out of business. 436)

Canada 3000 requested the Competition Bureau to intervene and stop Air Canada matching its prices through a new brand, Tango. Air Canada stated that it was not aware of any country in the world where a competitor was prevented from matching another competitor's initiated price especially where capacity has been reduced. 437)

Von Finckenstein K, the Commissioner of Competition of Canada, stated that Air Canada's discount Tango airline was partly to blame for Canada 3000's demise. Von Finckenstein K also stated that he was about to issue a cease-and-desist order against Tango when Canada 3000 went “belly up” but that the issue of the cease-and-desist order was delayed by the slow delivery of evidence from Canada 3000 executives. 438) In his opinion, Air Canada's discount brand Tango was an anti-competitive "fighting brand” although none of the bureau's allegations were proven before the Competition Tribunal. 439)

McTeague D supported the view that Air Canada acted to disrupt competition by cutting fares to unprofitable levels when rival carriers enter a particular route. McTeague D submitted that “Tango” was devised to be a fighting brand with the sole purpose of putting Chapter 8 Page 975 rival airlines out of business. In his view Tango exacerbated the financial troubles of Canada 3000 as it struggled to stay afloat. In his assessment Tango was a classic example of predation. 440)

During the actual operations of Tango, flights were routinely cancelled and that the passengers were re-booked on other Air Canada flights for the same price. Air Canada stated that one of the advantages of booking Tango was that Air Canada has the ability to protect customers on a mainline Air Canada flight if necessary. Air Canada notified customers a few weeks before their departure that their Tango flight had been cancelled, and their new Air Canada flight would now leave at a different time or date.

The head of competing airline WestJet, Beddoe C, stated that no other airline could get away with such a practice. In his assessment Tango was something of a phantom airline as it is “there one day and not the next, it's there for some flights and not the next, people are sold onto it when there's competition, when there's no competition it disappears”. 441)

It was alleged that the Canadian government funded Air Canada (through the compensation for the 11 September 2001 attacks on the USA during which the American skies were closed) in order to enable Air Canada to kill off its competition Canada 3000. Moore J stated in the Canadian Parliament that after the September 11 attacks the Canadian Transport Minister “gave C$100 million to Air Canada to cover its expenses for the two and a half days that the skies were closed. Days later Air Canada launched Tango, which the head of Canada's Competition Bureau says was anti-competitive and designed to run Canada 3000 out of business”. 442) He demanded to know why the Transport Minister did not make the C$100 million grant to Air Canada subject to a condition of that it was not to launch Tango and “destroy domestic air competition with taxpayers' money” as in his opinion, it is not up to the transport minister to finance the destruction of airline competition. 443) Air Canada has announced plans to expand the Tango programme, thereby reducing competition even further in Canada's skies.

Collenette D, the Minister of Transport, responded that with respect to competition policy there were certain guidelines and that it was up to the Commissioner of Competition to enforce those guidelines and not “up to the Minister of Transport to enforce the Competition Act”. 444) Chapter 8 Page 976

What is evident is that “Tango by Air Canada” was only launched following the receipt of governmental financial assistance (relating to compensation as a result of the closure of the skies to air navigation). Whether such financial aid was directly used in funding “Tango by Air Canada” is not clear. In any event, the improvement in the financial condition of Air Canada as an indirect result of such funding must have enabled Air Canada to launch the venture.

It is important to note that in dealing with any measure of financial assistance to an airline, appropriate measures should be taken by the government to ensure that such aid will not distort conditions in the market. In this regard, the extensive examples in Europe provide ample guidance with regard to government financial assistance to airlines. As was clear from this example in Canada, if adequate measures are not taken in setting conditions for such financial assistance contractually, such financial assistance can (and probably will) be used to eliminate smaller airlines faster than any effective measures can be taken by Competition Authorities to protect competition in the market.

8.22 FOREIGN ACCESS AND INVESTMENT AS A SOURCE OF COM- PETITION IN DOMESTIC AIR SERVICES

8.22.1 INTRODUCTION

In this section the possibility of granting access to foreign interests in Canada is discussed. It was evident that the restructuring of the airline industry in Canada resulted from the merger of Air Canada and CAI that formed a single dominant carrier. As a result of various interventions, the effect of certain of the barriers to entry were mitigated. The Commissioner of Competition identified certain government-imposed barriers to entry and recommendations. These included restrictions on foreign ownership of Canadian carriers as well as access to domestic air services to foreign airlines. The measures adopted did stimulate new competition to Air Canada, but much of such competition was lost as a result of the liquidation of Canada 3000. As a result, at the time of writing, the Canadian government was considering foreign access and involvement as a source of competition in domestic air services.

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Two approaches to granting such rights exist, that of unilateral action (by the Canadian government on its own) and an exchange of rights in terms of bilateral air services negotiations. As identified in this section, the Canadian Transportation Act Review Panel, the Canadian government and Air Canada preferred to negotiate such right for a common aviation area, much on the same lines as the EU utilising the NAFTA free trade area as basis for negotiating rights.

The Canadian Transportation Act Review Panel has also proposed a backup alternative of unilateral government action if the negotiations are not successful.

8.22.2 THE CENTRAL PROBLEM OF A DOMINANT AIR CARRIER

According to Stanbury WT and Ross TW of the University of British Columbia, the problem facing Canadian policy makers relating to the restructuring of the airline industry has several interrelated facets: 445) • A single, highly dominant (near monopoly) air carrier has replaced the duopoly of large-network carriers in Canada. 446) • This dominant (near-monopoly) carrier will operate “behind high barriers to entry”. 447) • Many of the key barriers are government created, e.g., the ban on cabotage, and 25 percent limit on foreign ownership. 448) • The Minister of Transport has announced in his statements that these key government-created barriers are sacrosanct, (are not subject to discussion). 449) • The interests of the most important “stakeholder” of all (Canadian air travellers) have been all but forgotten. 450)

8.22.3 RISK OF EXPLOITATION OF AIRLINE TRAVELLERS

Stanbury WT and Ross TW emphasised that airline travellers can be exploited in a host of ways other than by spectacular increases in fares that might cause negative political feedback. 451) These methods of exploitation include the following: • Fewer discount seats. (At present, some 90 percent of travellers obtain a discounted fare). 452)

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• “Shallower” discounts from the unrestricted economy fare (e.g., instead of the lowest fare for Vancouver-Toronto being C$469, it could be C$699). 453) • Reduced frequencies on many routes (city pairs). This is of most concern to business travellers for whom reduced total travel time is generally more important than the higher fares. 454) • Poor service by airline personnel. (The traveller’s frustration will be compounded by the inability to “vote with their feet” and take their business to a rival). 455) • Benefits from FFPs. (The dominant carrier will be able to unilaterally reduce the benefits from future flights and also “devalue” accumulated points). 456)

The fact that the dominant carrier may not be generating excess profits was, according to Stanbury WT and Ross TW, the result of the higher levels of revenues simply being absorbed into higher costs to appease the demands of organised and vocal interest groups, including: • Pilots. • Unionised employees, and • The federal government (which appears ready to impose a number of cost-increasing conditions on the dominant carrier during the restructuring, although none of these will benefit the air travellers). Effective competition forces firms to be as efficient as possible. 457)

8.22.4 IMPORTANCE OF BARRIERS TO ENTRY

Stanbury WT and Ross TW stated that if barriers are very low, even a true monopolist can not exploit its customers by raising prices and/or reducing the quality of service.

They grouped barriers to entry into three categories. 458)

These were: • Barriers to entry created by nature (and exogenous to government policy and industry participants). • Barriers to entry created by government(s) (including limits on foreign ownership). • Barriers to entry created by firms in the industry (including efforts to bar entry of competitors by anti-competitive behaviour).

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Stanbury WT and Ross TW regarded the government created barriers, namely a ban on cabotage and the 25 percent limit on foreign ownership of Canadian air carriers, as the largest regulatory barriers to entry into the airline industry in the same way as the Commissioner of Competition regarded it in his report to the Minister of Transport in 1999. 459)

According to Stanbury WT and Ross TW dominant or near-monopoly firms, protected by high barriers to entry, unfailingly exploit their market power. This takes a variety of forms: • Prices above the competitive level. 460) • Less variety than consumers want and are willing to pay for. 461) • Costs that are above the lowest attainable level - perhaps in the form of too many employees and/or paying wages and benefits above the competitive level. 462) • Service than would prevail in an effectively competitive industry, and 463) • (Possibly) cross-subsidisation in an effort to curry political favour to retain government created barriers to entry. 464)

According to Stanbury WT and Ross TW competition policy focuses on barriers created or maintained by firms. In most cases, competition policy cannot address barriers to entry created by government. 465)

Stanbury WT and Ross TW suggested that the government’s role is to help create an economic environment where there are strong incentives for producers of all kinds to serve the interest of consumers (Canadian air travellers in this case). 466)

In their assessment the best way to put such incentives in place was to encourage competition, whether domestic or foreign. They referred to a statement of the late Chinese Premier Deng Xiaoping, that it doesn’t matter if the cat is black or white, so long as it catches mice. Stanbury WT and Ross TW also stated that Canadian air travellers do not care that foreign investors own the company. In their assessment Canadian travellers want low fares, frequent flights, as well as good service in the cabin and on the ground. They were of the view that the best way to get that result is through competition. 467)

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Stanbury WT and Ross TW stated that the objective for policy makers should be to minimise barriers to entry so that other competitors can see if they can do a better job. In their view, competition is often a painful process (particularly for the losers) but because one major competitor can no longer stay in the game does not mean the industry is a “natural monopoly,” or the foreign competition should be excluded, or that the remaining dominant firm should be protected in any way from domestic or foreign competition. 468)

8.22.5 RELAXING OR REMOVING BARRIERS TO ENTRY

In its letter to the Minister of Transport in 1999, the Commissioner of Competition highlighted a number of important barriers to entry over which the government has some control. Relaxing or removing these barriers would have a beneficial effect on competition. These barriers include the following: • The restriction on foreign ownership of Canadian carriers. 469) • The 10 percent ownership rule for Air Canada. 470) • The scarcity of good takeoff and landing slots and terminal facilities at some airports. 471) • The current rules governing the CRS systems. 472) • Lack of fifth freedom (excessive restrictions in bilateral agreements) and modified sixth freedom rights for domestic and foreign carriers, and 473) • Strict rules on how large a foreign market must be before a second Canadian carrier is approved to serve it. 474)

The Competition Bureau also identified a number of strategies that the government could consider to reduce barriers created by the firms in the industry. These strategies included: • Granting access to established FFPs to new entrants. • Requiring code-sharing and interlining agreements requested by new entrants. • Restrictions on the use of TACOs. • New legislation to control predatory behaviour, and • Restrictions on how the dominant carrier must dispose of surplus equipment. 475)

In the view of Stanbury WT and Ross TW, the Competition Bureau was correct to place so much emphasis on barriers to entry in its advice to the Minister of Transport. Short of re-

Chapter 8 Page 981 regulation, lowering barriers to entry would be the only policy lever left for policy makers to counteract the monopolistic tendencies of a dominant carrier. 476)

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8.22.6 NATIONALISM IN RELATION TO THE ESTABLISHMENT OF AIRLINES IN CANADA

According to Stanbury WT and Ross TW, constraints on foreign ownership (of less than legal or effective control) of airlines are a means by which competition is restricted and certain domestic interests are protected and so earn more than they would in highly competitive markets.

According to Stanbury WT and Ross TW the protection of domestic firms in the name of nationalism has several notable characteristics: • It raises the costs of production (by attenuating the pressures of competition). • It raises the prices paid by domestic consumers (they become pigeons to be plucked). • Protectionism may well generate higher and/or more stable incomes for domestic owners and employees (all at the expense of consumers), and • It reduces the protected domestic firm’s ability to compete abroad (a contradiction in the age of globalisation). 477)

Stanbury WT and Ross TW proposed that competition from foreign sources could take a number of forms: • Foreign ownership (and control) of air carriers that serve domestic routes (In this regard, it was noted that foreign carriers serve Canadians on international and trans- border routes under a host of bilateral agreements.) 478) • Cabotage whereby a foreign airline offers service between two or more domestic points in conjunction with international service, 479) or • Modified sixth freedom routing as was proposed by the Commissioner of Competition. 480)

In the view of Stanbury WT and Ross T the elimination of the controls on foreign ownership (and cabotage) did not mean that the Canadian federal government would not or could not exercise notable controls over the industry, as: • The federal safety regulation regime is unchanged (as it is properly independent of economic regulation). 481)

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• The Competition Act applies to all rivals operating in Canada, regardless of ownership. 482) • If there were a national emergency, the Canadian federal government, by Cabinet order, could seize any aircraft on the ground in Canada and direct its use as it sees fit. 483)

With respect to carriers flying only domestic routes, Australia imposes no limit on foreign ownership. The Commissioner of Competition proposed a similar policy for Canada. Stanbury WT and Ross T submitted that such a policy could work very well for Canada, particularly in light of the need to encourage competition for the dominant carrier that will emerge out of the restructuring process. 484)

8.22.7 PROPOSALS FOR ENHANCING COMPETITION THROUGH FOREIGN COMPETITION

Several submissions to the CTA Review Panel offered suggestions for enhancing competition in the airline industry. Some groups recommended action to address specific competitive impediments; others proposed broader reforms, including removal of restrictions that prevent foreign airlines from competing in the domestic market. Several observers recommend removing legislative restrictions on foreign ownership of airlines operating within Canada. 485)

The CTA Review Panel was sympathetic to the view that the airline industry, like other sectors of the economy, should be subject to the stimulus and discipline of foreign competition. Greater competition in domestic and international aviation would make airlines more efficient and bring lasting benefits for users. 486)

The CTA Review Panel also recognised that airline markets do not conform to a vision of a free and competitive system for the overall market in air transport services worldwide as international markets are still dominated by the Convention on International Civil Aviation (the Chicago Convention) and its government-directed bilateral agreements. The CTA Review Panel noted that despite the Open Skies agreement, the US domestic airline market remains closed to non-nationals. Against this background, the Panel recommends a medium-

Chapter 8 Page 984 term policy approach for the airline sector that can be pursued through negotiations with the USA and other countries, along with more immediate actions to enhance competition in the domestic market. 487) As a result of the closed nature of international system of bi-lateral agreements in international air transport, the CTA Review Panel recommended that foreign access should be negotiated on government level with other governments. 488)

8.22.8 PROPOSALS FOR UNILATERAL ACTION TO ESTABLISH FOREIGN COMPETITION AND THEIR IMPLICATIONS

The Panel considered two proposals for unilateral action to introduce foreign competition in the domestic market without violating Canada's bilateral agreements or the Chicago Convention. 489) • The first proposal (termed “modified sixth freedom rights”) would allow a US carrier to fly passengers from one point in Canada to another point through a US interchange. For example, a US carrier could offer a service from Toronto to Vancouver via Minneapolis. A US airline can currently sell a trip from Toronto to Minneapolis and a second trip from there to Vancouver, but the two cannot be marketed and sold as a single ticket. 490) • The second proposal would create a new class of domestic carrier that could be 100 percent foreign-owned. Australia took this step in June 1999. Since the new class of carrier would be allowed to fly only in Canada, the argument that ownership restrictions are needed to designate national carriers under bilateral and international agreements does not apply. 491)

These reforms, recommended by the Commissioner of Competition and others, were intended to attract some foreign entrants to the domestic market. The implications according to the CTA Review Panel were: 492) • By opening the domestic market to foreign carriers, Canada would gain access to a broader pool of airline entrepreneurial and management talent. 493) • Participation by foreign carriers was likely to reduce opportunities for independent Canadian Airlines. 494)

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• While Air Canada competed successfully against US carriers in the trans-border market, CTA Review Panel regarded Air Canada as being in a transition period, absorbing the adjustment costs associated with its acquisition. Air Canada would also be handicapped temporarily by its legally enforceable undertaking not to lay off or relocate unionised workers for two years after the takeover and to serve all domestic points previously served by the two airlines for three years. 495) • The CTA Review Panel also stated that modified sixth freedom rights could also seriously affect the Canadian air cargo industry. Under the “scope clause” in their contracts with pilots, Federal Express, UPS and other US companies are bound to use their own aircraft and pilots on all jet category routes into their hubs and all routes where they have a right to fly. The CTA Review Panel concluded that with modified sixth freedom rights, there would be less demand for Canadian carriers to provide trans-Canada flights for US cargo/courier companies. 496)

8.22.9 RECOMMENDATIONS OF THE CTA REVIEW PANEL

Balancing these considerations and taking account of the rigidities of the international regime in air transport (especially US reluctance to give any foreign carrier access to its lucrative domestic market without major offsetting concessions), the CTA Review Panel opposed unilateral action to allow foreign entry in its final report. The Panel recommended that the government should instead pursue foreign competition by negotiating for liberalisation of air services. A priority should be to expose air services to the benefits of North American free trade. 497)

The Panel recommended that the government enter into negotiations with the USA and Mexico to create a North American Common Aviation Area in which carriers from Canada, the USA and Mexico would compete freely. 498)

As a back-up option (in the event that such negotiations for a North American Common Aviation Area do not succeed) the CTA Review Panel recommended that the government negotiate with other countries for: • The reciprocal granting of modified sixth freedom rights. Under this proposal, Canadian, Mexican and US carriers could compete in each other's domestic market.

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The rights of establishment proposed, as a back-up option would be extended to any country prepared to offer equivalent rights to Canada. 499) • The reciprocal granting of rights of establishment for foreign-owned domestic carriers. Foreign carriers that took advantage of the right would have to establish separate Canadian subsidiaries that employ Canadian workers, pay taxes, and operate generally under the same conditions as Canadian-owned airlines. 500)

The CTA Review Panel stated that bilateral negotiations have been successful in expanding choices for Canadian passengers on trans-border and international routes, and the Panel was of the opinion that bilateral negotiations can be effective in strengthening competition in the domestic market. If negotiations fail, however, the government must be prepared to adopt another course of action. By 2005, it should be apparent whether negotiations with the USA and/or other countries are likely to result in stronger competition in the domestic market and increased opportunities for Canadian carriers, or whether a different approach is required.

With recent legislation aimed at controlling Air Canada's market power, Canadian policy has turned 180 degrees from earlier years, when Air Canada was an instrument of government policy and the focus was on protecting the country's national airline from undue competition. Throughout the 1980s, government dismantled most of the restrictions limiting the ability of Canadian carriers to respond to market forces, paving the way for development of a competitive industry offering more frequent flights, fares that better reflected airlines' costs, and a significant range of price and service offerings. 501)

8.22.10 THE CONCERN OVER THE HIGH MARKET SHARE OF THE DOMINANT AIRLINE (AIR CANADA) FOLLOWING THE COLLAPSE OF CANADA 3000

The sudden collapse of Canada 3000, the country's second-largest carrier, left Air Canada in virtually total command of the skies with an 80 percent market share. 502)

Remaining rivals accused Air Canada of predatory pricing on the routes that they served and the government admitted that something should be done to boost competition. The collapse of Canada 3000 as well as a dramatic slowdown in air travel that followed the suicide attacks

Chapter 8 Page 987 on the USA of 11 September 2001 crushed the Canadian government’s objective of serious domestic airline competition. The government also proposed changing competition legislation to ensure that any airline found guilty of trying to force a competitor out of business could be hit with a C$15 million ($9.5 million) fine. 503)

Collenette D stated that the “status quo is unacceptable to the government, to the public and to Air Canada in terms of their market share so we have to find ways of rebalancing it”. 504) As a result, certain changes were implemented in the Canadian Competition Act as noted in 8.23.6 below.

Collenette D also told reporters the current situation of the dominant airline Air Canada with a 80 percent market share of the domestic air transport market was unacceptable. He stated that he was prepared to: 505) • Re-regulate the aviation industry, or 506) • Throw it open to foreign competition by: o Modified sixth freedoms (modified sixth freedoms would permit US airlines to offer flights between Canadian destinations through US hubs). o Cabotage (Cabotage would allow US airlines to operate on Canadian routes). 507)

Collenette D was of the opinion that some way needs to be found in which an orderly reduction in the domestic market share of Air Canada can be achieved in a way that makes it commercially attractive for them. Collenette D also warned Air Canada that its plan to start up a no-frills carrier in Western Canada would not be good for the country. 508)

8.22.11 PROPOSALS TO INCREASE COMPETITION THROUGH FOREIGN SOURCES

In advising the government of the issue of airline restructuring in October 1999, the Competition Bureau made the following three recommendations: • Create a new class of licensee under the CTA to allow 100 percent foreign ownership of carriers that can fly only within Canada.

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• Make legislative changes to the CTA to allow modified sixth freedoms, either on a unilateral or reciprocal basis. • Permit up to 49 percent of the voting shares of a Canadian carrier to be held by foreigners. 509)

The Commissioner of Competition was of the view that the market structure of the Canadian airline industry, where one player held in excess of 70 percent of the market and the remaining share was fragmented among smaller rivals, is not optimal from a competition perspective. His conclusion was that in order for the industry to become more competitive, the recommendations above to increase foreign competition were necessary. 510)

From the above it is clear that the barriers to entry into the domestic air transport market dominated by a large network carrier, develop to such an extent that fundamental steps need to be taken to promote competition. As a result of inadequate development of local competition, the Canadian Commissioner of Competition proposed the insertion of foreign competition.

Milton R the president and chief executive officer of Air Canada stated on 6 December 2001, in a news release, that Air Canada had previously indicated to the Minister of Transport that it “might be open to a domestic re-regulation of all carriers operating in the country if that was government policy”, that was “clearly not the preferred option for ensuring a competitive, efficient industry”. 511) In addition, Air Canada stated that it would “not support re-regulation if it involved any expropriation or indirect transfer of market share, routes or assets” of Air Canada. 512) Milton R was of the opinion that a truly competitive environment cannot be developed in Canada by resorting to outmoded regulatory remedies 513) such as: • Limiting the number of carriers allowed to serve a market or a particular route. 514) • Imposing frequency restrictions. 515) • Capacity restrictions. 516) • Pricing restrictions, or 517) • Nationalising the flag carrier. 518)

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Air Canada's proposal followed on Minister Collenette's earlier statement that the government would look at other competitive options 519) such as identified in 8.22.7 above. These options were: • More foreign competition. • Modified sixth freedoms, or • Cabotage as an alternative to re-regulation to increase competition in the Canadian domestic market.

On 6 December 2001 Air Canada proposed a full open skies agreement between Canada and the USA to the Minister of Transport Collenette and US Transportation Secretary, Mineta, creating an unrestricted, single aviation market with the USA as the preferred option to fostering a competitive airline environment in Canada. 520)

Air Canada urged the Canadian and US governments to build on the success story of the 1995 Canada-US Open Skies Agreement by “progressively removing all restrictions in order to arrive at a fully integrated, common air transport market with the USA”. According to Milton R a fully liberalised Open Skies Agreement including the exchange of “modified sixth freedom opportunities” leading to full “continental cabotage rights” would “fully respond to the concerns” of all stakeholders concerned with Air Canada's dominance of the Canadian industry". 521)

8.22.12 PROMOTION OF A NEW NORTH AMERICAN AIR POLICY “OPEN SKIES PLUS” FOR THE 21ST CENTURY BY AIR CANADA

A relaxation of access restrictions across borders of Canada and the USA requires a re- negotiation of bi-lateral air services agreements by the two governments. As a result, Air Canada needed to obtain sufficient support of US carriers in order to convince them to influence their government (the USA) to re-negotiate the bilateral air services agreement with the Canadian government towards the direction that Air Canada proposed to the Canadian government on 6 December 2001. 522)

In a briefing to chief executive officers of US airlines on 13 December 2001, Milton R proposed a North American Air Policy for the 21st Century based on a modified sixth

Chapter 8 Page 990 freedom and unrestricted open skies air services agreement to consumers and carriers on both sides of the border. This approach has become known as Air Canada’s “Open Skies Plus” proposal that was based on the current USA “Open Skies” model with full competition between USA and Canadian hub airports (controlled by hub-dominated airlines). 523)

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Drumming up support for his proposals made to the Minister of Transport in Canada, Milton R stated that opportunities existed to further liberalise the USA-Canada air services agreement. 524) In his view these would include: • An unrestricted Open Skies Agreement with the USA would be consistent with the government’s policy of facilitating trade across the USA-Canada border, as supported by business leaders and provincial government officials. 525) • “Modified sixth freedom” would create more service options in both the USA and Canadian domestic markets by allowing USA and Canadian carriers to carry the local domestic traffic of either country through their own hubs. Milton R also stated that a number of Canadian scholars and economists suggested the adoption of a modified sixth freedom right during the Canadian transportation Act Review Panel process in 2001. 526) • “Modified sixth freedom” would allow all hub airports and carriers on both sides of the border to fully compete for all traffic flow, including domestic, as they now do in respect of trans-border and international traffic. This would create additional service options for both USA and Canadian consumers as well as allow carriers and airports in both countries to take further advantage of their hub infrastructure and network synergies. 527) • An expanded air services agreement would include unlimited fifth freedom rights for passenger and all-cargo operations; in other words, the right of an airline to carry passengers between foreign countries (e.g. AA carrying passengers between Toronto and London, or Air Canada carrying passengers between Los Angeles and Sydney). 528) • The expanded air services agreement would also include the right for all-cargo carriers to serve points in the other country on a co-terminal basis, and full routing and pricing flexibility on all service operations including to third-countries. 529)

According to Milton R President and Chief Executive Officer Air Canada, he was gratified to see a “lot of positive reaction. The US government, through the American Embassy in Ottawa, the Air Transport Association of Canada, and US carriers such as American and Northwest Airlines have all reacted favourably” to the proposal of Air Canada. 530) He also stated that Air Canada was also discussing his proposal with officials from both the USA and

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Canadian governments with the aim of getting negotiations started as quickly as possible. 531) 8.22.13 IMPLICATIONS OF THE PROPOSALS OF FOREIGN ACCESS OF AIRLINES IN CANADA ON SOUTH AFRICA

At the time of writing, this new approach relating to an extensive revision of the air services agreement between the USA and Canada had not yet progressed sufficiently for a conclusive opinion to be formed of the direction in which the proceedings in this matter (Foreign Access) will be heading. This approach, if successful, could offer some guidelines relating to opportunities for application of a more relaxed approach to access to airlines situated in the neighbouring countries of South Africa and opportunities in and from South Africa.

This type of approach might be a faster method of achieving regional liberalisation in Southern Africa than an emulation of the approach adopted in Europe by first establishing a similar super-national system like the EU, which is later extended to transport.

Solely from a domestic competition point of view it would seem that restrictions on foreign investment in domestic airlines as well as the local registration requirements for aircraft operated on domestic air services were at least contributory to the undercapitalisation of smaller competitors (in specific Canada 3000) that did not have the sustainability to absorb a number of financial shocks, many of which were attributable to the large downturn in passenger volumes as a result of the 11 September 2001 attacks in the USA. It would appear as if there was some correlation between Air Canada obtaining financial aid from the Canadian government and its launch of the “Tango by Air Canada” concept, which had an effect on Canada 3000, providing impetus leading to its closure. No conditions appear to have been imposed by the Canadian government on Air Canada relating to its competitive position in the market for obtaining such Sate financial assistance. Some allegations were made that the Canadian government effectively killed competition in the domestic air services market. As was clear from this example in Canada, if adequate measures are not taken in setting conditions for such financial assistance contractually or by some enforceable mechanism, such financial assistance can (and probably will) be used to eliminate smaller airlines faster than any effective measures can be taken by Competition Authorities to protect competition in the market. This is also the case in South Africa, where there was no evidence that advice had been obtained from the Competition Authorities was obtained or that the Chapter 8 Page 993

Competition Authorities were involved in providing SAA and Transnet with substantial financial aid in the form of debt relief as identified in 6.5.2 and 6.5.4 of chapter 6. It would appear that Canada is considering granting direct access to US foreign airlines to the Canadian domestic market by granting of modified sixth freedom rights or cabotage rights to either US airlines or to the American government in order to develop competition in the air transport market in Canada, where a dominant domestic airline exists. Historically, measures requiring Canadian control were instrumental in effectively protecting Air Canada against strong vigorous competition.

The probability is that, while the proposals of Air Canada might stimulate a measure of competition from US airlines, competition will be based on a bilateral air services agreement (instead of open access to the market). The bilateral air services agreements normally restrict competition and the timing thereof in terms designations and procedure by the two governments (that of the USA and Canada).

In other words, such foreign competition would be of a more restrictive nature in competitive terms than that one would expect in a situation of a relatively free entry to the market through unilateral action by the Canadian government (which it is entitled to take) and has been adopted by Australia (by means of the concept of foreign owned domestic carriers adopted recently). To eliminate restrictions on the ownership of domestic airlines would assist in the capitalisation of smaller airlines that do not have access to government guarantees for the acquisition of aircraft and ensure their “staying powers” especially if shareholding of such airlines is also held by substantial overseas airlines with the natural consequences of linking into a larger international network.

Air Canada and the US airlines have also recently been the beneficiaries of large state financial aid by their respective governments without any measures (as have been taken by the EU) that attempt to limit the effect that such aid might have on distortion conditions in the market (refer to section 4.11.1 in chapter 4). In any event, the financial aid available to US airlines by far exceeds that granted to Air Canada by the Canadian government. As a result, Air Canada might find that a “level playing field” between all participants in the new market being established by the Open Skies Plus programme might not exist in future. This may result in interesting jurisdictional issues with regard to the application of competition/antitrust laws and regulations at that stage. Chapter 8 Page 994

The loss of Canada 3000 also implies that the fleet of aircraft that was to be Canadian registered will inevitably be lost to Canada as the leased aircraft would be returned to their (probably foreign) owners and remaining assets sold during the winding up exercise. As a result, the lack of effective measures to promote competition (by means of smaller Canadian airlines) resulted in a reduction of Canadian aircraft available from a strategic point of view. Most of Canada’s “eggs” are therefore now “in one basket” so to speak, with the obvious increase in overall risk to Canada. As has been demonstrated by the recent failures of Swissair and Sabena, economic conditions can dramatically move against the size (scope) of airlines in cases of an overall large and sudden downturn in traffic volumes. In other industries this risk is managed by an economic limit on the size of a participant in the market, the “optimum size” of a firm in terms of risk management. This risk would, however, seem to be underwritten by a number of governments that effectively “bail out” airlines as soon as large-scale downturn in volumes takes place. In the long run it may be more beneficial to have a number of sizable airlines from a risk perspective. In as much as South Africa exhibits similar characteristics to Canada with regard to a large dominant airline, the abovementioned risks should be avoided and an active programme should be embarked upon to promote competition through the reform of regulations, the restructuring of the SOE, SAA, and the restructuring of the institutions as identified in chapter 3.

8.23 CTA REVIEW PANEL

8.23.1 INTRODUCTION TO THE CTA REVIEW PANEL

The final report, Vision and balance of the CTA Review Panel (that contained more than 90 recommendations) was submitted to the Minister of Transport on 28 June 2001 and tabled in Parliament on 18 July 2001.

The work of the CTA Review Panel was intended to be one of the building blocks in the development of a new transportation blueprint for Canada as part of the transportation blueprint project (that also included the government climate change timetable as well as the that the outcomes of the Millennium Transportation Conference, that was arranged by the Minister of Transport in June 2000) and that the Transport Minister launched earlier in 2001 Chapter 8 Page 995 to develop a framework that will guide future decisions in transportation over the next decade and beyond. 532)

8.23.2 CTA REVIEW PANEL FINDINGS AND RECOMMENDATIONS RELATING TO THE AIRLINE INDUSTRY

The CTA Review Panel concluded that airline restructuring had different implications in the USA than in Canada, where the result was one major carrier. Recent developments in the Canadian airline industry also underscored the challenges of attempting to create conditions to sustain a competitive airline industry in the relatively small Canadian market compared to that of the USA.

The CTA Review Panel recognised that although regional airlines play an important role as feeders to Air Canada, in most of the regional markets there was no alternative scheduled or charter service to that of Air Canada. The CTA Review Panel stated that these markets appear “contestable”, but that prices were generally not subject to competition from other market participants. 533)

The CTA Review Panel was of the opinion that Air Canada's acquisition of Canadian Airlines International (CAI) did not affected trans-border and international markets in the same way as domestic markets, but that it had affected competition among the global airline alliances vying for international traffic. Air Canada belongs to the Star Alliance, the largest group, whose senior North American member is United Airlines. 534)

Through alliances, airlines gain access to larger international networks, and membership in an alliance tends to enhance an airline's productivity and profitability. The CTA Review Panel stated that competition might be weaker in markets served by partner airlines of an alliance. It was of the view that in the current Canadian circumstances, trans-border and international competition was somewhat reduced due to the significant advantage that is produced by Air Canada's well developed domestic feeder network gives members of the Star Alliance. 535)

The CTA Review Panel also found evidence suggesting that Air Canada may be charging higher interline fares to non-Star Alliance foreign carriers which in its opinion supported the Chapter 8 Page 996 concern that the dominance of Air Canada in domestic markets was affecting competition in trans-border and international markets. The UK Civil Aviation Authority, for instance, reports that Air Canada increased the interline fare offered by BA on the Toronto-Ottawa route segment from the C$389 charged by CAI to C$1,189.12 Such practices can reduce travel options and inhibit effective competition. 536)

8.23.3 IMPEDIMENTS TO COMPETITION IN THE CANADIAN AIRLINE INDUSTRY

Competition from independent carriers can potentially have a major influence on airline fares according to the CTA Review Panel. It noted that in the US SWA has exerted strong downward pressure on prices since deregulation in that "actual, potential and adjacent competition" from SWA has accounted for an estimated 40 percent (amounting to US$9.7 billion) of the annual savings from lower real fares from deregulation”. 537)

CTA Review Panel stated that the evidence is less dramatic in Canada, but here, too, research shows that competition from a low-cost carrier tends to reduce air fares. The benefits of competition cannot be enjoyed by all Canadian passengers; many markets are simply too small to support more than one carrier. On routes where it is feasible, however, competition may not be realised because of the formidable impediments confronting existing independent carriers and new entrants.

The high-risk nature of the airline industry tends to discourage entry. Because airlines have high fixed costs relative to revenues, a small change in load factors or fare levels can have a large impact on profits. The industry is therefore highly vulnerable to an economic slowdown. Among the independent carriers, WestJet stands out for its success in controlling costs and sustaining profitability. 538)

CTA Review Panel stated that the greater risk for independents and new entrants arises from the difficulties of competing with a large carrier with strong market advantages. The CTA Review Panel identified the following strengths of Air Canada: • The extensive domestic network of Air Canada. • The ability of Air Canada to offer frequent flights.

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• Air Canada’s control over the main available FFP. • The well developed marketing and distribution system of Air Canada. • The favourable position at Pearson, Canada's major airport and the hub for domestic air traffic. • The successful combination of a marketing strategy aimed at attracting business travellers with a sophisticated yield management system that allows Air Canada to adjust fares to appeal to more price-sensitive travellers. • Following the takeover of CAI, Air Canada has a denser network that should produce cost savings from better aircraft utilisation (including larger planes, higher load factors, and increased aircraft use) and more efficient use of ground personnel and equipment. 539)

It should be noted that South African Airways has the same market advantages within a South African context as Air Canada has in Canada as identified in chapter 6.

8.23.4 LEGISLATIVE CHANGES OF 2000

The CTA Review Panel regarded the legislative changes of 2000 as being aimed to reduce industry entry barriers. It observed that, in line with the undertakings Air Canada made to gain approval of its CAI acquisition: • Air Canada has given up a number of peak-hour slots at Pearson and made available facilities at selected airports where it had preferred or exclusive use of more than 60 percent of facilities. 540) • Air Canada must also offer interlining and joint fares to other Canadian carriers belonging to the International Air Transport Association and, for a five-year period, sell access to its Aeroplan to Canadian carriers below a size threshold (C$250 million in domestic passenger revenues). 541) • In addition, amendments to the Competition Act gave the government greater authority to: o Address airline-specific anti-competitive acts, and o Ensure access to essential facilities including: Š Take-off and landing slots. Š Interline arrangements.

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Š Airport gates. Š Loading bridges. Š Counters, and Š Related airport facilities. Š Maintenance services, and Š Baggage handling infrastructure, equipment and services. 542)

The CTA Review Panel regarded these reforms as important, but stated that there was scope for additional measures in some areas. 543)

Over the longer term, the CTA Review Panel regarded vigilance by the Competition Bureau as the most important check against practices that limit entry to airline markets. Experience in Canada and elsewhere suggested that the best hope for developing competitive markets ultimately rests with talented airline managers who can design and implement a business model that makes sense in the context of market realities. 544) The government must ensure that, where Air Canada is in a position of dominance, it does not abuse its market power. Beyond that, the role of government is to establish an environment that fosters the entrepreneurship needed to build a more competitive airline sector. 545)

8.23.5 ADDITIONAL MEASURES FOR ELIMINATING POTENTIAL BARRIERS TO ENTRY

The CTA Review Panel proposed three additional measures to promote a more level playing field in the domestic air transport industry.

8.23.5.1 Authority for the CTA to settle disputes over access to Airport Facilities

The policy must recognise the importance of assuring new entrants reasonable access to airport facilities. The CTA Review Panel stated that the concern went beyond limitations in available slots, gates and other facilities that may arise at certain airports at specific times (discussed in amendments to the CTA in 2000). 546)

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The CTA Review Panel stated that a more general concern is that Air Canada may be in a position to exercise inordinate influence over key airport decisions. Dependent as they are on establishing favourable relations with the dominant carrier, airport authorities may place greater emphasis on accommodating Air Canada than on giving independent airlines high- quality access at a reasonable price. 547)

The Panel was sympathetic to the view that airports should treat gates and other airside facilities as common use facilities, available for rental by all. In the meantime, to ensure that airport access does not impede market entry, airlines should have recourse for treatment they believe is unfair in terms of price or quality of service. As a result, the CTA Review Panel recommended that carriers be given recourse to the CTA for disputes over access to airport facilities and that the Agency be given power to provide an appropriate remedy in situations where airlines are found to be subject to unfair treatment in terms of prices charged or type and quality of services provided. The Agency would likely become involved only in disputes the parties cannot resolve on their own, and its powers would be directed only to resolving situations where airlines had been clearly and significantly disadvantaged. In these circumstances the Agency could issue an order requiring specified improvements in facilities and related services and/or that charges be reduced. 548)

8.23.5.2 Access to the FFP of Air Canada

Under the legislative provisions Air Canada was required to sell access to Aeroplan, to eligible carriers that must have annual domestic revenues of less than C$250 million. This is a relatively low revenue ceiling that excluded some independent carriers and Air Canada's obligation extended only until 2005. The CTA Review Panel proposed to expand coverage and to make access to Aeroplan available as long as Air Canada continues to occupy a dominant position in the domestic market. 549)

The CTA Review Panel recommended that: • The maximum annual domestic passenger revenues used to determine eligibility for access to Air Canada's FFP be raised to C$500 million. 550)

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• The requirement to provide access to Aeroplan be extended until the Minister of Transport determines that competition in the domestic market has strengthened to the point where it is no longer necessary. 551)

8.23.5.3 Rates for interlining and other services to foreign airlines outside the Star Alliance

The CTA Review Panel was concerned about a possible impediment to trans-border and international competition if Air Canada charges excessive rates for interlining and other services to foreign airlines outside the Star Alliance. Airlines belonging to OneWorld and other alliances can establish interlining and joint fare agreements with independent Canadian carriers as an alternative to relying on Air Canada.

The CTA Review Panel was of the opinion that the latter would be a positive development as along with facilitating transborder and international competition, it could help strengthen the position of the independent airlines as competitors in the domestic market.

The Panel considered the desirability of regulating interline charges but wanted to avoid recommending any action that might discourage a market-based solution. In addition, regulations limiting interline charges would be difficult to enforce.

The CTA Review Panel recommended a more transparent system where passengers could readily compare prices on flight options. 552)

8.23.6 REVISION OF CANADIAN COMPETITION ACT FOLLOWING THE COLLAPSE OF CANADA 3000

As a result of the lack of competition in the domestic air transport market in Canada, leading to foreign access proposals referred to in 8.22.7, 8.22.11 and 8.22.12 above, Tobin B, the Canadian Industry Minister, also tabled amendments to the Competition Act aimed at Air Canada. They provided for fines of up to C$15-million if an airline is convicted of predatory behaviour and would allow temporary cease-and-desist orders against an airline to be indefinitely extended while the Competition Commissioner seeks evidence of predatory

Chapter 8 Page 1001 behaviour. In addition, Collenette D, the Canadian Transportation Minister Collenette D stated that the amendments were a form of regulation, but more action may be required to reduce the market share of Air Canada as, in his view, the resultant “status quo” was unacceptable, to “the government, to the public, and to Air Canada in terms of their market share”. 553) A number of Competition Act amendments followed the collapse of Canada 3000. These are primarily: • Revision of the ability of the Commissioner of Competition to issue a temporary cease and desist order The Commissioner of Competition can issue a temporary cease and desist order under section 104.1 of the Act in specific circumstances: o An inquiry must have been commenced, and o There must be reason to believe that competition will be Š Harmed, or Š A competitor eliminated if the order is not made.

Two amendments were proposed by the Competition Bureau to address perceived inadequacies in the present Competition Act with respect to the airline industry in order to: o Close the gap that can occur after the expiry of temporary cease and desist orders issued by the Commissioner against a competitor (by permitting extensions of temporary orders) until the Commissioner has received the relevant information to determine whether to file an application with the Tribunal, and o Permit the Tribunal to assess an administrative monetary penalty (AMP) against an airline, when it has issued an order under section 79, the abuse of dominance section of the Competition Act. 554)

The abovementioned measures affecting the airline industry are examined more in depth below. • The time gap between the expiry of a cease and desist temporary order and the time when an application is brought before the Competition Tribunal

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As a result of the enforcement experience relating to temporary cease and desist orders, the Competition Bureau stated that a gap could exist between the time a temporary order expires and the time the Commissioner is able to bring an application before the Tribunal. It was of the opinion that it was essential to eliminate this gap as the competitor against whom the order was made could otherwise recommence the anti-competitive behaviour before the Commissioner has made the application before the Tribunal with the possible result that the injured competitor may be eliminated from the market. The Competition Bureau stated that such a result would defeat the very purpose of both the temporary cease and desist order and the application under section 79 of the Competition Act (abuse of dominance).

If the Commissioner has not received the necessary information from the subject of the inquiry or any other person (which must furnish information consistent with court orders such as section 11 orders, or informally through undertakings) and has not had a reasonable period of time to review the information, the Commissioner will not be in a position to determine whether an application should be filed under section 79. 555) • Administrative monetary penalty (AMP) The Competition Bureau stated that the AMPs are being added to encourage compliance with the abuse of dominance provisions of the Competition Act in the airline industry. The C$15m maximum on penalties permits the Tribunal latitude in setting an appropriate amount depending on the case. The ceiling value is sufficiently high to encourage compliance with section 79. 556) • Authority to the Competition Tribunal to issue an interim order in terms of section 103.3 of the Competition Act According to the Competition Bureau, the new section 103.3 of the Competition Act provided the authority to the Competition Tribunal to issue an interim order to prevent irreparable harm to competition, while the investigation of a complaint by the Commissioner is still underway. An interim order may be issued by the Competition Tribunal upon application made ex parte by the Commissioner of Competition in respect of all reviewable matters under Part VIII of the Competition Act, except mergers and specialisation agreements. 557)

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The Competition Commissioner must certify in the application that an inquiry is being made under section 10(1) (b) of the Competition Act. The Competition Tribunal has to find that the conduct or the measures taken are likely to result in the following before it issues an interim order: o Cause injury to competition that cannot be remedied by the Tribunal. o Eliminate a competitor, or o Cause a person to likely suffer a significant loss of revenue or market share, or suffer some other harm that cannot be remedied by the Tribunal. 558) The Interim Order would have effect for an initial period of 10 days. It may be extended for two periods of 35 days each on 48 hours notice to each person against whom the interim order is directed. A further extension may be granted by the Competition Tribunal, upon application by the Competition Commissioner on notice, until such time as the Competition Commissioner is able to receive and review the information needed to determine whether to make an application before the Competition Tribunal. The person against whom an Interim Order has been made may apply to the Competition Tribunal in the first 10 days during which the order has effect to have it varied or set aside. 559)

It should be noted that although very similar in nature to the provisions of the powers of the Competition Commissioner relating to the airline industry in terms of section 104.1 of the Canadian Competition Act, the powers conferred to the Competition Tribunal are not limited to any particular industry but could be applied to the airline industry. A comparison between the powers of the Competition Commissioner (relating to temporary cease and desist orders) and that of the Competition Tribunal (relating to interim orders) is attached as annexure “AK”.

Dawson D, Segal J and Rendall C stated that this new provision has not yet been used, and similar authority applying solely to the airline industry (introduced in July 2000) has been used only once by the Competition Commissioner. They were not sure whether the requirements of the Canadian test were less onerous than the requirements for an interim injunction (interdict). 560)

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• Summary It is evident that the experience in Canada demonstrated the importance of temporary cease and desist orders to protect competition in the airline industry. Owing to attempts to use the legal system to delay the hearing and final adjudication of cease and desist orders it became necessary to narrow the gap in time that could exist between the time a temporary order expires and the time the Commissioner is able to bring an application before the Tribunal, and to encourage compliance with the abuse of dominance provisions of the Competition Act in the airline industry.

The Competition Bureau was of the opinion that these measures were necessary given the instability in the airline industry which has resulted from the events of 11 September 2001. The collapse of Canada 3000 and the likelihood of new start-up airlines made it especially important, in this challenging market environment, to ensure that the airline market in Canada is competitive. 561)

8.23.7 POWER OF COMPETITION COMMISSIONER TO ISSUE TEMPORARY CEASE AND DESIST ORDERS DECLARED INOPERATIVE BY THE COURT OF APPEAL OF QUEBEC

The power of the Competition Commissioner to make a provisional order against Air Canada section 104.1 of the Competition Act was declared to be inoperative by the Quebec Court of Appeal on 16 January 2003 being regarded as incompatible with section 2(e) of the Canadian Declaration of Rights and the Canadian Constitution Act of 1867. 562)

Air Canada contested section 104.1 of the Competition Act as being contrary to the rules of natural justice: • Nemo judex in sua causa (the right to an impartial hearing), and • Audi alteram partem ("no one is fit to be the judge in his own case" - the right to be heard) which is protected by section 2(e) of the Canadian Declaration and the powers reserved to the Superior Courts according to section 96 and the preamble of the Canadian Constitution Act of 1867. 563)

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Air Canada argued that the power conferred upon the Competition Commissioner was not justifiable in the circumstances. 564)

The provisional order authorised by section 104.1 of the Competition Act could be rendered ex parte and renewed twice for supplementary periods of thirty days on each occasion. No contest or judicial review was permitted during this period of up to eighty days. However, any person affected by such an order may request that the Competition Tribunal modify or nullify it. 565)

The Court of Appeal noted that such an order by the Competition Commissioner affects rights of individuals. In considering the severe consequences of such an order, the Court of Appeal concluded that it was reasonable that any person targeted by such an order should have the right to be heard before the order is rendered. The Court of Appeal concluded that the level of respect for the rules of natural justice must be "substantial" given the context. 566)

Paragraph 2(e) of the Canadian Bill of Rights provides “2. Every law of Canada shall, unless it is expressly declared by an Act of the Parliament of Canada that it shall operate notwithstanding the Canadian Bill of Rights, be so construed and applied as not to abrogate, abridge or infringe or to authorise the abrogation, abridgement or infringement of any of the rights or freedoms herein recognised and declared, and in particular, no law of Canada shall be construed or applied so as to … (e) deprive a person of the right to a fair hearing in accordance with the principles of fundamental justice for the determination of his rights and obligations”. 567)

Air Canada alleged that the structure of the Act created an institutional bias contrary to the rule nemo judex in sua causa. The Court of Appeal noted that the Competition Commissioner was placed “in charge of both the enquiry commenced following a complaint by one of Air Canada’s competitors, that this enquiry continues during the duration of the provisional order, and that the Commissioner acts as respondent in any appeal of his provisional order before the Tribunal”. 568) The Court of Appeal concluded that these different functions of the Commissioner were incompatible with the impartiality required in order to judge whether or not the proof submitted meets the conditions for a provisional order according to section 104.1 of the Act. 569) Chapter 8 Page 1006

Analysing section 104.1 of the Act according to the rule audi alteram partem, the Court of Appeal noted that any form of hearing is excluded by the Act, even during the renewals of the provisional order. The minimal guaranties of natural and procedural justice were therefore not satisfied. 570)

As a result, the Court of Appeal granted the appeal and declared that section 104.1 of the Competition Act as inoperative and incompatible with section 2(e) of the Canadian Declaration of Rights and the Canadian Constitution Act of 1867. 571)

This would have been fatal for the attempts of the Competition Commissioner in Canada to establish a mechanism that would be effective in protecting competition in the air transport industry faced with an overall dominant airline.

Fortunately, section 103.3 was introduced in the amendments of the Canadian Competition Act 1985 which took effect from June 2002, to enable the Competition Commissioner to make an ex parte application to the Competition Tribunal for an interim order preventing a corporation or individual from engaging in conduct that is alleged to be anti-competitive, for example, for abusing a dominant market position. 572) As noted in 8.23.6 above, the scope of this section that confers the power to the Competition Tribunal is not limited to the air transport industry only but to all types of anti-competitive conduct envisaged in the Canadian Competition Act.

Such an interim order is made for an initial period of 10 days. Following 48 hours' notice to a person affected, the order may be twice extended by up to 35 days. The Competition Tribunal may thereafter grant a further extension of the order where the Competition Commissioner needs more time to obtain information for the inquiry. A person affected by the order may, within the first 10 days after the order has come into effect, request the Competition Tribunal to vary or set aside the order, but there is no appeal to other courts.

The Competition Tribunal may make an interim order only if it considers that the conduct in question could be of the type otherwise prohibited by the Act and if, without such an order, “injury to competition that cannot adequately be remedied by the Tribunal is likely to occur” or “a person is likely to be eliminated as a competitor” or “suffer a significant loss of market Chapter 8 Page 1007 share, a significant loss of revenue or other harm that cannot be adequately remedied by the Tribunal”. 573)

It is not clear what the constitutional position South Africa will be relating to the basis on which the powers of the Canadian Competition Commissioner were challenged by Air Canada being the right to an impartial hearing and the right to be heard and whether the same consequences would result. As a result, it is important to consider these aspects in framing the authority for the Commissioner of Competition and the Competition Tribunal in South Africa based on the recommendations in this regard.

It should be noted that in its considerations, the Quebec Court of Appeal in Canada, specifically took note of the similarity between the basis on which of the Competition Tribunal could grant an interim order preventing a corporation or individual from engaging in alleged anti-competitive conduct as contained in section 103.3 of the Canadian Competition Act and the powers of the Canadian Competition Commissioner in granting a cease and desist order in terms of section 104.1 of the Canadian Competition Act. Richter CL stated that the Court of Appeal noted that the Act grants similar powers to the Tribunal under section 103.3, enacted on 21 June 2002. Richter CL also established that the Respondent, the government of Canada, had “not demonstrated the necessity of granting the power to make provisional orders to the Commissioner, rather than relying upon the powers of the Competition Tribunal under section 103.3 of the Act. 574)

Although this only deals with competition in the domestic air transport field, it may be advantageous to adopt such measures in the South African economy generally or in particular with regard to network industries that have a number of economic characteristics that are of a similar nature to that of the air transport industry. This aspect should however be researched further as it falls outside the scope of this dissertation.

8.23.8 CONCLUSION OF THE COMMISSIONER OF COMPETITION

The Commissioner of Competition concluded that the recent entry and consolidation, which occurred in the market, did not change the fact that Air Canada remains in a dominant market position. Air Canada did not face effective competition on a national basis, or for the

Chapter 8 Page 1008 important business sector where flight frequency and network connections are imperative. 575)

The Commissioner of Competition was of the opinion that the new provisions introduced to the Competition Act to respond to potentially anti-competitive behaviour on the part of Air Canada were helpful, but that such measures would not on their own be sufficient to create a competitive domestic airline market. As a result, the Commissioner of Competition recommended that the “domestic market should be opened to greater foreign competition”, along the lines of the October 1999 letter of the Commissioner of Competition to the Minister of Transport. 576)

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8.24 INSTITUTIONAL ARRANGEMENTS OF THE COMPETITION AUTHORITIES IN CANADA

8.24.1 THE RESPECTIVE ROLES AND RESPONSIBILITIES OF THE COMPETITION BUREAU AND INDUSTRY REGULATORS AS REGULATED INDUSTRIES ARE EXPOSED TO COMPETITIVE FORCES

8.24.1.1 Introduction

Certain guiding principles for getting right the roles and responsibilities of regulators and the Competition Bureau in industries like transportation, telecommunications, financial services and upstream natural gas, as well as other industries in transition to competition, were developed from the experience of the involvement of the CCB in the deregulation of the Canadian economy, from the development of supporting legislation and continuing through to the final deregulation of markets.

Owing to the fact that Canada started its regulatory reform before South Africa, and in some respects carried its reform further with regard to the deregulated and privatisation of state enterprises, some reference is made to the institutional arrangements of the Competition Bureau and Industry Regulators as regulated industries are exposed to Competitive Forces in Canada.

Lafond A, discussed the management of the roles and responsibilities of the Competition Bureau and industry regulators within the existing Competition Law and Policy framework in Canada relating to competition-related matters.

He was of the opinion that under that framework, an Australian or New Zealand approach to industries like electricity and telecommunications, in which the competition authority is also the regulator, is not workable as the Competition Bureau in Canada does not have the mandate or authority to regulate industries, and there is no Canadian government intention to give the Competition Bureau such a role.

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Lafond A stated that industry self-regulating mechanisms could also play key roles in making the transition from regulation to competition. The possible roles of provincial government departments and agencies should also be taken into consideration. There should also be appropriate constraints on the behaviour roles of other agencies or organisations during the transition from regulation to competition. 577)

8.24.1.2 Various principles in assigning and coordinating the roles and responsibilities of the Competition Bureau and Regulators

Lafond A outlined seven guiding principles for assigning and coordinating the roles and responsibilities of the Competition Bureau and to regulators in the transition to competition. 578) These are: • Put Competitive Market Structures in Place as Soon as Possible Lafond A was of the opinion that governments and regulators ultimately are responsible for the establishment of competitive market structures in making the initial move out of regulation. The role of the Competition Bureau at that stage should be the provision of advice and analysis to governments and regulators on how to implement pro-competitive reforms as one of the key ways of achieving the objective under the Competition Act to promote competition to the benefit of Canadians. 579) • Give the Regulator an explicit role to promote competition Lafond A also stated that the Competition Bureau supports regulators having an explicit role to promote competition. This objective should according to him, not be to promote competition for its own sake but should be to promote competition as a way to achieve the efficient and innovative production and supply of products, meeting consumers' demands at the lowest possible cost. 580)

Two important purposes were served by giving the regulator a role to promote competition. It placed an onus on regulators to minimise restrictions on competition in order to achieve any other of their goals or objectives. An express objective of fostering increased reliance on market forces and ensuring that regulation, where required, is efficient and effective. 581)

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• Regulatory control over excessive pricing due to incumbent market power Lafond A stated that there should be regulatory control over excessive pricing due to the market power held by market incumbents. If a previously regulated company has excessive market power, competition law cannot prevent the use of that power to obtain high prices. 582) • Regulatory control over access to essential facilities If there are essential facilities in an industry, access to them should be subject to regulatory control. Lafond A stated that Canadian competition law was not as well suited as industry specific regulation to deal with market access issues in such cases. It was also necessary to prevent the excessive pricing of essential facilities due to any market power residing in them. 583) • Rely on competition law to prevent anti-competitive business practices unless regulation is demonstrably better According to Lafond A, competition law provided an established set of disciplines for dealing with such practices where they create a significant threat to competitive markets. These should be relied on unless regulation is clearly more effective, taking into account the nature of the regulatory framework being put in place and the potential for dealing with the relevant business behaviour under the Competition Act. 584) • Create mechanisms for removing regulation when the costs outweigh its benefits Lafond A stated that effective mechanisms should be put in place to ensure that regulation is removed when the costs of regulation outweigh its benefits. These mechanisms include either the sunsetting of regulation, or the use of regulatory forbearance provisions. 585) • Measures for coordinating roles and responsibilities to minimise overlap and duplication Lafond A stated that it was important that measures for effectively coordinating the roles and responsibilities of the Competition Bureau and the regulator be put in place in order to minimise unnecessary overlap and duplication. The basis for these arrangements would be an exchange of letters between the regulator and the Bureau. These would not require either organisation to give up jurisdiction. Rather, their purpose would be to clarify each organisation's roles and responsibilities, help coordinate interventions in the relevant sector, minimise overlapping or duplicative

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investigations and remedies, and create a more certain business environment within which firms can operate. 586)

8.24.1.3 The need for clarity regarding the roles and responsibilities of regulators and the Competition Bureau

Lafond A, stated that clarity regarding the roles and responsibilities of regulators and the Competition Bureau and the effective coordination of these roles and responsibilities was in everybody's interest. 587)

8.24.2 KEY COMPETITION ISSUES IN THE AIR TRANSPORT MODE

Addy GN stated that the airline sector has attracted considerable attention in recent years. In his assessment this was due, in part, to recurring high levels of excess capacity, fare wars and financial instability. According to him, some observers interpreted this situation as being evidence of a "failure" of deregulation. Addy GN stated, however, that a strong argument could be made, that the difficulties that major air carriers have experienced in the past (in both the USA and Canada) are due, not to intrinsic problems with deregulation, but to an over-expansion of capacity and related managerial decisions taken in the late 1980s. A similar conclusion was reached in the report of the National Transportation Act Review Commission in Canada. 588)

Addy GN stated that some key challenges remained for competition in the air transport mode including: • International alliances among airlines that gather momentum. He was of the opinion that such market changes may necessitate re-examination of some longstanding policies, such as the existing restrictive limits on foreign investment in Canadian carriers. 589) • While recognising the need to carefully consider the potential benefits of some form of rationalisation, he was of the opinion that it was vital to preserve a healthy degree of inter firm rivalry in the provision of services. Experience in the USA affirmed that competition helps to keep rates low and provides a desirable incentive for efficient

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service. In his view this translated into important competitive advantages for user industries. 590)

The guidance of the experience in Canada for South Africa is that the following issues need to be monitored very carefully, in order to consider preventative action: • High levels of excess capacity. • Fare wars. • Financial instability. • Other over-expansion of capacity and related managerial decisions rather than the failure of deregulation, as the root cause of problem situations. • International and domestic alliances. • Re-examination of some longstanding policies, such as the existing restrictive limits on foreign investment in carriers. • Preserving a healthy degree of inter firm rivalry. 591)

8.25 SUMMARY AND CONCLUSIONS

8.25.1 PURPOSE AND OBJECTIVES

In this chapter the salient aspects relating to competition in the domestic airline industry in Canada, as a result of the deregulation of domestic air transport services in Canada and the subsequent consolidation of the industry in an overall dominant airline environment, Air Canada were discussed. In particular, the occurrence of predatory practices in the airline industry in Canada, a combination of the provision of too much capacity and lowering of air tariffs were examined in order to establish what remedies were adopted by the Canadian government to prevent anti-competitive behaviour in the airline industry in order to foster competition.

Specific objectives that were identiied, are: • The salient aspects of the development of deregulation in the Canada were established. These included:

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o The advice and recommendations of the Commissioner of Competition of the Competition Bureau on restructuring of the airline industry in Canada as identified in 8.7. o Revision of the Canadian domestic air transport policy as identified in 8.8. o Enforceable undertakings to enhance competition in a restructured airline industry provided by Air Canada to the commissioner of competition as identified in 8.10. o Canadian airline restructuring legislation as identified in 8.11. o Enforcement guidelines on the abuse of dominance in the airline industry as identified in 8.12. o Foreign access and involvement as a source of competition in domestic air services as identified in 8.22. • The advice and recommendations of the Commissioner of Competition of the Competition Bureau on restructuring of the airline industry in Canada to the Minister of Transport were identified in 8.7. • The revision of the Canadian domestic air transport policy was documented. A number of aspects relating to the Canadian domestic air transport policy were re- evaluated by two parliamentary committees that conducted hearings and consulted widely. The following aspects are relevant within the South African context and the views of various Canadian governmental institutions were considered and evaluated: o Canadian ownership and control (discussed in 8.8.2). o The 10 percent percentage limitation on individual holdings of Air Canada (discussed in 8.8.3). o Measures to foster competition and protect the public interest (discussed in 8.8.4 and 8.8.5). o Measures to protect of consumers apart from competition issues (discussed in 8.8.6). o Predatory behaviour (discussed in 8.8.7). o Barriers to entry (discussed in 8.8.8). o Airport access and airport facilities (discussed in 8.8.9). o Encouraging discount carrier operations in Eastern Canada (discussed in 8.8.10). o FFPs (discussed in 8.8.12).

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o TACOs (discussed in 8.8.13). o Surplus aircraft (discussed in 8.8.14). o CRS (discussed in 8.8.15). o Pricing - unreasonable fare increases (discussed in 8.8.16). o Interlining and code-sharing (discussed in 8.8.19). o Regional carrier divestiture (discussed in 8.8.20). o Domestic competition from foreign owned airlines - reciprocal cabotage (discussed in 8.8.23). o Canada-only carriers (discussed in 8.8.24). o A modified sixth freedom (discussed in 8.8.25). o Monitoring commitments by a dominant carrier (discussed in 8.8.26). o Airline alliances (This aspect affects a wide range of airline practices and principles discussed in 8.3, 8.7.2, 8.8.2, 8.8.6, 8.8.8.3, 8.8.8.4, 8.8.8.58.23.2 and 8.24.2). o Financial fitness test (this aspect, although relevant to South Africa, however falls outside the scope of this dissertation). o Prohibition on ticket sales prior to licensing (some provision has already been made in South Africa in this regard, but this aspect however, falls outside the scope of this dissertation). • The enforceable undertakings provided by Air Canada to the Commissioner of Competition to enhance competition in a restructured airline industry were identified in 8.10 and 8.11.3.1. The undertakings required Air Canada to inter alia: o Surrender slots and facilities at airports. o Sell surplus aircraft to Canadian operators. o Try to sell Canadian Regional Airlines Limited. o Provide access to its FFP. o Provide access to interlining and joint fare agreements. o Change the way incentive override commissions are paid to travel agents, and o Refrain from starting any discount air carrier operations in Eastern Canada for a specified period of time. • The Canadian airline restructuring legislation was documented that included: o Measures that were adopted to enhance consumer protection (discussed in 8.11.2) including:

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Š Monopoly pricing (discussed in 8.11.2.1). Š Conditions of carriage (discussed in 8.11.2.2). Š Commitment on service - notice of exit (discussed in 8.11.2.3). Š Monitoring by an independent observer (discussed in 8.11.2.5).

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o Measures that were adopted to foster competition (discussed in 8.11.3), including: Š Undertakings made by Air Canada (discussed in 8.11.3.1). Š Predatory pricing (discussed in 8.11.3.2). Š Travel agents (discussed in 8.11.3.3). o Certain enforcement guidelines on the abuse of dominance in the airline industry were introduced which included the ability to grant, cease and desist orders relating to the abuse of dominance provision by the competition authorities (discussed in 8.12.2 and 8.12.3). o The airline regulations enacted following restructuring of the Canadian airline industry (discussed in 8.12.1 and 8.12.2). o The definition of anti-competitive acts by legislation and regulations (discussed in 8.12.2 and 8.12.5). o The grants of a temporary cease and desist order relating to the abuse of dominance provision by the Competition Tribunal (discussed in 8.12.3 and 8.15.3). o The identification of the occurrence of anti-competitive acts in the airline industry by means of the avoidable cost test (as compared to the average variable cost test) (discussed in 8.12.5.1.1). o Certain arrangements were also made by means of enforcement guidelines relating to the commercial conduct by airlines including FFPs, TACOs, corporate discount programmes and other anti-competitive practices that could substantially prevent or lessen competition (discussed in 8.12.6). • The actual working of the regulatory steps that were adopted in Canada with regard to complaints raised by new entrants and smaller airlines against the conduct of Air Canada were assessed. These included: o General fare reductions by Air Canada, which gave rise to complaints by smaller competing airlines (Westjet, Canjet, discussed in 8.15 and at a later stage Roots Air, discussed in 8.16) and the granting of a temporary cease and desist order against Air Canada. o Conversely, fare increases by Air Canada on monopoly routes operated by Air Canada in which regard the CTA ruled that such fares of Air Canada were unreasonable (too high) (discussed in 8.21).

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The evaluation of the regulatory steps adopted in Canada with regard to the promotion of competition in the air transport industry in Canada in the future was assessed. Owing to the lack of competition and the resultant high market share of the dominant airline (Air Canada) following the collapse of Canada 3000, as identified in 8.22.5.4, proposals were made to increase competition through foreign sources 8.22.5.5. In this regard, Air Canada and the Canadian government proposed a New North American Air Policy “Open Skies Plus” for the 21st Century as identified in 8.22.12. This has certain implications for South Africa. • Advice and institutional arrangements of the Competition Authorities in Canada was considered in 8.7.

8.25.2 OVERALL SUMMARY OF THE CHAPTER

Deregulation in the USA had a profound impact on the strategic development of airlines all over the world and definitely in Canada. The commercial practices and tactics adopted in the USA were also adopted by airlines in Canada and South Africa.

The salient aspects with regard to the deregulation of domestic air transport services in Canada and resulting competition between airlines was discussed in this chapter.

Deregulation of the domestic airline industry in Canada evolved from 1988 onwards and following a number of mergers, resulted in a market basically dominated by two major domestic airlines, Air Canada and Canadian Airlines. As such, the deregulation process in Canada started slightly before deregulation in South Africa (which kicked off in 1990).

There was concern that the weak financial position of Canadian Airlines would either lead to a single large air carrier being created through a merger, acquisition or other means, such as a business failure, or alternatively, the two major carriers could come under common ownership. Under either scenario, one entity or the commonly controlled entities, would offer most of the services and carry the majority of passengers in Canada. Three options were considered by the Canadian government for dealing with the problem: • To help Canadian Airlines financially. • To allow the bankruptcy of Canadian Airlines, and

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• To restructure the industry in some way. A corporate bidding war developed in Canada spurred by an initial offer by ONEX as well as an American company, AMR (the holding company of AA) in competition to a counter offer by Air Canada both with the intention to consolidate the two major airlines, Canadian Airlines and Air Canada into one single airline as discussed in 8.3. A court ruling that maintained the then legal limit of 10 percent of ownership of shares in Air Canada by a single shareholder proved to be the catalyst to provide control over the merger in favour of Air Canada. The issue of foreign ownership in Canadian airlines (and the possible role of AA) appeared to be more important than the concerns relating to substantial concentration in the market and its resultant negative effect on competition.

A number of factors caused concern that the reduced level of competition would have negative connotations from a consumer perspective. These were: • The overwhelming dominance of the remaining national carrier. • The difficulty of successful entry, the lack of effective remaining competition, and • The prohibition of foreign competition in domestic markets.

Faced with the imminent prospect of what essentially would amount to a private sector monopoly in air services the Minster of Transport, the Competition Bureau and the Commissioner of Competition initiated a number of measures with the objective of mitigating competition concerns by: • Reducing entry barriers. • Facilitating new entry. • Expansion by remaining competitors, and • Restricting the ability of the dominant carrier to engage in anti-competitive acts.

Government involvement in restructuring of air transport in Canada called on the advice and recommendations of the Commissioner of Competition of the Competition Bureau relating to conditions to remedy the substantial lessening of competition as identified in 8.7). A number of aspects relating to the Canadian domestic air transport policy were re-evaluated by two parliamentary committees that conducted hearings and consulted widely (discussed in 8.8).

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As a result of the process, certain measures were adopted: • Certain enforceable undertakings to enhance competition in a restructured airline industry were provided by Air Canada to the Commissioner of Competition (discussed in 8.10). • Legislation was passed relating to Canadian airline restructuring (discussed in 8.11).

From a timing perspective, the developments in Canada took the regulatory developments in the USA with regard to the proposed policy relating to unfair exclusionary conduct in the air transportation industry (referred to in 7.6, 7.7 and 7.9.5 of chapter 7) further. Due to the urgency of the situation in Canada a range of regulatory steps were taken and implemented. As was expected, Air Canada abused its dominance following the merger and the Competition Authorities issued cease and desist orders to protect competition. This issue is discussed in section 8.15.4. Legal action tested the working of the framework that was implemented in Canada. As a result, the developments in Canada could act as a guide for South Africa in terms of measures that need to be taken to foster competition in the air transport industry.

There was a divergence of views between the Canadian government and the Commissioner of Competition, the SCOT and the Senate Committee on Transport and Communications on the other side, relating to raising the foreign ownership limit in Canada's airlines to 49 percent. The government of Canada stated that it was not convinced that raising the current 25 percent limit on foreign ownership in the industry would be beneficial (discussed in 8.8.2).

The limit on individual holdings of Air Canada of 10 percent (that was the pivoting issue in the bidding war for control over the consolidation of air transport services in Canada) was increased to a new level of 15 percent in order to increase investment and provide Air Canada with the stability it needed during the transition period (discussed in 8.8.3).

The Competition Bureau identified the Canadian government’s policy on foreign ownership and its policy on cabotage as the largest regulatory barrier to entry into the airline industry. The Competition Bureau recommended that the government reconsider this policy as a result

Chapter 8 Page 1021 of the development of a dominant carrier. It also proposed three alternatives to stimulate competition: (discussed in 8.8.7). • Domestic competition from foreign owned airlines on the basis of reciprocal Cabotage (in particular with the USA) (discussed in 8.8.9.1). • Canada-only carriers (government policy regarding ownership and control would be amended to allow carriers that would be licensed to serve only domestic routes and could be foreign owned up to 100 percent) (discussed in 8.8.9.2), and • A modified sixth freedom that would as example allow a US carrier to pick passengers up in Montreal and fly them to Vancouver via Chicago (discussed in 8.8.9.3).

The Commissioner of Competition concluded on 8 May 2001 that following the failure and subsequent acquisition of Canadian Airlines by Air Canada the level of competition in domestic airline markets dramatically reduced as a result he was of the view that: • The need for significant legislative and regulatory changes to promote competition in the airline industry remained strong. • The related regulations defining anti-competitive practices and powers to issue temporary cease and desist orders during the course of inquiries were essential. • There was a desirability of allowing greater foreign participation in the domestic airline market and the following was recommended: o To allow 100 percent foreign ownership of carriers that can fly only within Canada. o To allow modified sixth freedoms, either on a unilateral or reciprocal basis. o Permit up to 49 percent of the voting shares of a Canadian carrier to be held by foreigners.

The undertakings made by Air Canada in negotiations with the Competition Bureau contributed in reducing barriers to entry and facilitating competition in the domestic airline market but such measures would not (on their own) be sufficient to create a competitive domestic airline market that would be sustainable in the light of the dominance of Air Canada. As a result, the Commissioner of Competition recommended certain enhancements of the competition rules applicable to air transport and that the domestic market should be opened to greater foreign competition (discussed in 8.22.2).

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The proposals of the Commissioner of Competition relating to the issue of foreign competition were supported by Stanbury WT and Ross TW of the University of British Columbia (discussed in 8.22.5) that regarded it as one of the key barriers to entry that was government-created, general support from the CTA Review Panel (discussed in 8.23.2) the Transport minister Collenette D was of the opinion that situation of the dominant airline Air Canada with an 80 percent market share of the domestic air transport market was unacceptable. He stated that he was prepared to: • Re-regulate the aviation industry, or • Throw it open to foreign competition, by o Modified sixth freedoms (modified sixth freedoms would permit US airlines to offer flights between Canadian destinations through US hubs). o Cabotage (cabotage would allow US airlines to operate on Canadian routes) (refer to 8.22.5.4).

Following the collapse of a substantial new competing airline, Canada 3000, the Canadian government and Air Canada embarked on a new initiative to negotiate reciprocal Cabotage and modified sixth freedom rights through the promotion of a New North American Air Policy termed “Open Skies Plus” for the 21st Century in order to rely on foreign sources for competition in the domestic market of Canada. (Refer to 8.22.12) This clearly demonstrates that if effective measures are not taken to preserve competition in the air transport market, sustainable domestic competition will not be possible and foreign access in some format will be the only avenue to establish meaningful competition in domestic markets.

8.25.3 SPECIFIC ASPECTS IDENTIFIED IN THE CHAPTER THAT ARE RELEVANT TO SOUTH AFRICA

8.25.3.1 Applicability of the developments in Canada to South Africa

The central competition problem facing Canadian policy makers, relating to the restructuring of the airline industry, has several interrelated facets that are similar to those faced in South Africa: • A single, highly dominant (near monopoly) air carrier.

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• This dominant (near-monopoly) carrier operates “behind high barriers to entry”. • Many of the key barriers are government created, e.g. the ban on cabotage, and percentage limitations on foreign ownership. • The interests of the most important “stakeholder” of all (air travellers) do not feature substantially in policy development. 592)

To a large extent the abovementioned factors are also relevant with regard to competition in the domestic air transport market in South Africa, with the added effect that State ownership of the national carrier and the resultant financial support that is available to SAA.

Canada is in aviation terms geographically located between the USA and UK and Europe and as a result subject to developments in all these territories.

The air traffic in Canada is much smaller than in the USA, the UK and Europe (South Africa’s largest trading partners).

In addition, South Africa shares somewhat of a similar history with Canada, both were former dominions within the British Empire and are currently members of the Commonwealth of Nations. 593)

South Africa also originally drew from the wording of the Canadian Air Services Act in drafting the Air Services Act 1949 and the Competition Legislation in South Africa has drawn substantially on Canadian Competition Legislation. 594)

8.25.3.2 Ownership and control of domestic airlines

There appears to be a major focus on Canadian control and ownership over all Canadian businesses including domestic airlines. Investment Canada Act applies when a single foreign investor acquires more than 33⅓ percent of any Canadian enterprise. This Act permits foreign shareholdings in a Canadian company up to 50 percent less a share, provided that these shares are widely held and that management control remains with Canadian shareholders. As a result, unlike most other countries where ownership and control requirements is a specific feature relating to civil aviation regulation, Canada has a general

Chapter 8 Page 1024 concern relating to ownership and control of enterprises, probably due to its closeness to the USA as identified in 8.8.2.

Effective control and ownership is jealously guarded in the USA mostly for reasons of national safety and military preparedness. Within Europe, a concept of European ownership has developed and establishment rules have been relaxed substantially.

In South Africa where in terms of the White Paper on Reconstruction and Development (RDP) of 15 November 1994 it was stated that the South African "government welcomes foreign investment" and the “principle of national treatment will apply to foreign investors, who would enjoy the same treatment as domestic investors". 595) Yet, the foreign ownership level for domestic airlines has been set at 49 percent in South Africa. 596) Although this level is higher than that that has been applicable in Canada, later developments in Canada resulted in the acceptance of the principle of granting sixth freedom and cabotage rights in order to develop competition in the domestic market in Canada. It would therefore seem that should this level of foreign investment in domestic airlines be abolished, such domestic airlines could be foreign owned but would be fully subject to domestic laws, which might be a better alternative to develop competition.

The Competition Bureau in Canada considered that the policy on foreign ownership as one of the largest regulatory barriers to entry, and suggested that it stated that the government may wish to reconsider this policy if a dominant carrier emerges. The Competition Bureau focused on the need for access to foreign capital for airlines. In their view the airline industry was capital-intensive. The Competition Bureau identified one of the major reasons for failure in the airline industry as undercapitalisation. It was of the view that new entrants have a critical need for capital from both domestic and foreign sources and recommended raising the limit on foreign ownership of voting shares to increase access to foreign capital for carriers competing with the dominant carrier and to provide a greater incentive for foreign carriers to strike up alliances with a domestic carrier other than the dominant one.

Although the SCOT supported this approach and the Senate Committee on Transport and Communications, the Canadian government retained the 25 percent limit on foreign ownership for domestic airlines in Canada.

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Stanbury WT and Ross TW of the University of British Columbia (refer to 8.8.2) supported the increase of foreign investment/ownership limit on the basis that it would make it easier for new Canadian carriers to attract foreign capital and through equity swaps with other airlines, expertise so long as effective control remained firmly in Canadian hands) The CTA Review Panel also supported this approach but the Transport Minister Collenette D informed the House of Commons that 25 percent limit on individual foreign ownership would not be changed.

The view of the Minister of Transport Collenette D changed later as a result of a collapse of domestic competition as is evident in the section dealing with ownership and control of domestic airlines in 8.22, which might hold some guidance for South Africa. The statement of 28 October 1999 was however very similar to the sentiments expressed by the then Minister of Transport in South Africa on 10 October 1997 when the possibility of participation in the privatisation of Sun Air by a large foreign airline such as BA or Singapore Airlines was ruled out on the basis that it would give them a strategic foothold here and enable them to undercut South African Airways. This clearly indicated the objective to protect the national carrier SAA from meaningful sustainable competition or perhaps the intent to protect the investment of the state in SAA as identified in 6.4.2.2.

An interesting development adopted in June 1999 in Australia has been the elimination of all restrictions on ownership of domestic airlines in order to assist in the capitalisation of smaller airlines that do not have access to government guarantees.

This approach would require a change to RSA government policy regarding ownership and control of a domestic airline. A carrier would be created that would be licensed to serve only domestic routes and could be up to 100 percent foreign owned as identified in 8.8.9.2 of this chapter. Should such principles be applied to the South African context, such an the airline would have to: • Use primarily South African crews. • Comply with all South African laws and regulations, including labour legislation, and • Be subject to the same competitive conditions as any other South African carrier operating in the domestic market.

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• Pay South African taxes.

The Competition Bureau in Canada was of the opinion that this would allow for greater access to foreign capital to finance Canadian airline operations and could align new entrants with knowledgeable foreign operators who have the expertise to operate as effective competitors to the dominant carrier. As a result, the ability of domestic airlines to be 100 percent foreign owned would assist in the funding of aircraft and operations to provide the “staying power” required by smaller airlines when faced by a state controlled dominant airline. In this regard such an investment by a substantial overseas airline would also provide the benefits of linking into a larger international network as well with the standards of services strived for within such alliances.

Air Canada submitted several significant differences between the air transport markets of Australia and Canada in the context of airline ownership, according to which the air transport market in South Africa, in the writer’s opinion, has in some respects similarities to Australia when compared to Canada as identified in 8.8.9.2 above: • Australia is geographically isolated while Canada is not. In this regard, South Africa is similarly geographically isolated from major air transport markets. • Canada was adjacent to one of the largest, most aggressive and competitive aviation industries in the world. The geographical remoteness of South Africa implies that a number of cost-related benefits would not be transferable if full foreign ownership of domestic airlines were to be allowed. • Any carrier operating in Canada and owned by US interests would be closely linked with a US carrier, or fully integrated with the US carrier. Within the South African context, the geographical remoteness of South Africa would limit the possibility of operational integration of a fully-fledged domestic fleet of aircraft with that of long haul intercontinental aircraft.

Concerns of Air Canada relating to a full subsidiary of an American airline based in Canada included that the cost structure of a US owned carrier was much lower than that of similar Canadian carriers. Air Canada feared this low cost structure would be “perpetuated” in Canada. The cost differential would probably be the same in comparing US carriers to South African airlines, but the geographical remoteness of South Africa would imply that a local

Chapter 8 Page 1027 subsidiary of an American airline operating in South Africa would be subject to much of the same operating cost drivers affecting other South African carriers. Within the Canadian context, Air Canada was of the opinion that aircraft maintenance would take place in the USA and that as a consequence, investment would take place in the USA and not Canada. Save for major aircraft overhauls, this would probably not apply within the South African context as a result of the geographical remoteness of South Africa and the high cost of ferrying empty aircraft.

Air Canada also identified that the relatively small size of Canada’s domestic air transport market made it less inviting to AA than was generally thought. In this context the small size of Canada’s domestic market was seen as the biggest barrier to new entry by AA. This would probably also be applicable to the South African context with an even smaller air transport market size than that of Canada. As a result of the geographical remoteness of South Africa, from a competition perspective, it is submitted that there will be little to be feared by abolishing the ownership requirements for domestic airlines in South Africa.

On the same basis as Stanbury WT and Ross TW identified that eliminating the controls on foreign ownership (and cabotage) did not mean that the Canadian federal government would not or could not exercise notable controls over the airline industry, this would also be the case with such an application in South Africa. The safety regulation regime would be unchanged and the Competition Act would apply to all rivals operating in South Africa, regardless of ownership and in the event of a national emergency, the government could seize any aircraft in South Africa in terms of the Defence Act (on much of the same basis as in Canada) and direct its use as it sees fit. In terms of section 100 the South African Defence Act 44 of 1957, the State President may commandeer (take possession) of aircraft necessary for mobilisation or the maintenance of the South African Defence Force with an obligation to pay compensation. In terms of section 102 the South African Defence Act 44 of 1957, the State President may for a number of purposes assume control over any air service or any portion thereof within the Republic of South Africa. In addition, the Minister of Defence may (under certain conditions) requisition any transport system or air service to supply engines and aircraft for the conveyance (of members of the defence force or nursing service etc) from any point within or outside the Republic as may be necessary. 597) As such, the authority to use aircraft for military purposes in South Africa exists whether such airline or aircraft is South African or foreign owned. Chapter 8 Page 1028

As noted in a previous study, the actual experience in South Africa during the Second World War was that foreign airlines (BOAC, SABENA and Southern Rhodesian Airways) were able to operate domestic services in South Africa at very economical terms, when all the resources of SAA were transferred to military use. 598) Canada’s regulatory and infrastructure cost base was not the same as the USA. In Canada domestic fuel taxes were higher and airport navigation fees were historically higher than in the USA. International user charges were much higher than domestic user charges in Canada.

Depreciation of the Canadian dollar against the US Dollar and workforce levels were also operational cost aspects. The substantially higher fuel prices paid by Canadian airlines than those paid by US carriers were as a result of higher domestic fuel taxes in Canada. There were also differences in fleet composition as well as credit worthiness/risk of the carriers. In the same way, the costs are expected to be higher in South Africa.

The SCOT in Canada also identified that foreign control can be exercised through service and maintenance contracts, and through additional measures other than equity ownership. The Committee was of the view that an examination of foreign ownership and control issues must go beyond equity considerations alone and that such issues must be analysed within a broader context. In addition, it was identified that both Air Canada and CAIL received financial backing from their overseas alliance partners. It was noted that both the two major Canadian airlines were heavily dependent on these overseas partners. Some witnesses felt that the airlines were to a large degree controlled by the alliances. This could imply that members of an alliance have to a large degree to fall in line with the overall objectives of the alliance rather than its own objectives. As such, the historical use of a national airline as an instrument of national governmental policy is in the context of an airline alliance subject to the overall alliance objectives.

Apart from the controversy surrounding the foreign ownership issue the SCOT also stated that Canada's air carriers were operating within a global context and as such require new tools (alliance agreements) to survive in this environment. As a result, there were also concern that there were ways around the restrictions pertaining to foreign ownership of airlines as financially a foreign airline may not be a controlling owner, but could well function as an influential banker for operators in a very capital intensive industry. All these Chapter 8 Page 1029 aspects bring into question the advisability and feasibility of restrictions on foreign ownership and control.

As a result of the above, there appears to be little overall risk in following the Australian example of lifting the foreign ownership rules for domestic airlines operating in South Africa, save for the protection of existing airlines and especially the state owned airline SAA from competition.

8.25.3.3 Implications of the proposals of foreign access of airlines in Canada on South Africa

At the time of writing, this new approach relating to an extensive revision of the air services agreement between the USA and Canada had not yet been progressed sufficiently to form a conclusive opinion of the direction in which the proceedings in this matter (Foreign Access) will be heading. This approach, if successful, could offer some guidelines relating to opportunities for application of a more relaxed approach to access to airlines situated in the neighbouring countries of South Africa and opportunities in and from South Africa.

This type of approach might be a faster method of initiating regional liberalisation in Southern Africa than an emulation of the approach adopted in Europe by first establishing a similar super-national system like the EU, that was later extended to transport. As a result, it is recommended that the grant of consecutive cabotage rights to airlines operating on international services from regions that South Africa would like to establish regional trading agreements, be investigated and considered as a catalyst for the first step in establishing a regional transport agreement. Certain conditions might have to be applied to ensure that competition takes place on an equal footing like similar rules relating to CRS, rules preventing state aid and competition rules and philosophy. These might be contractual or parties could agree to South African jurisdiction in this regard. Consecutive cabotage rights would only confer domestic pick-up and put-down rights within South Africa on aircraft that operate to and from South Africa on regional services. Owing to the limited number of frequencies operated by neighbouring airlines to South Africa, the impact on smaller airlines should not be substantial. It may also result in a closer co-operation between smaller airlines in South Africa and airlines within the region in order to provide distribution, advertising, handling services and capacity agreements. This could be done on a time-limited scale and be Chapter 8 Page 1030 followed by reciprocity requirements from the home countries of airlines to which such rights have been granted.

Solely from a domestic competition point of view it would seem that restrictions on foreign investment into domestic airlines as well as the local registration requirements for aircraft operated on domestic air services was at least contributory to the under-capitalisation of smaller competitors (in specific Canada 3000) that did not have the sustainability to absorb a number of financial shocks, many of which was attributable to the large downturn in passenger volumes as a result of the 11 September 2001 attacks on the US commercial passenger aircraft.

From 8.21 above, it would appear as if there was some correlation between Air Canada obtaining financial aid from the Canadian government and its launch of the “Tango by Air Canada” concept, which had an effect on Canada 3000, providing impetus leading to its closure. No conditions appear to have been set by the Canadian government on Air Canada relating to its competitive position in the market for obtaining such State financial assistance. Some allegations were made that Canadian Airlines effectively killed competition in the domestic air services market. As was clear from this example in Canada, if adequate measures are not taken in setting conditions for such financial assistance contractually or by some enforceable mechanism, such financial assistance can (and probably will) be used to eliminate smaller airlines faster than any effective measures can be taken by Competition Authorities to protect competition in the market. This demonstrates the importance of involvement or advice of the Competition Authorities relating to the state ownership and possible grant of financial assistance to SAA and Transnet in South Africa.

It appears as if Canada is heading in the direction of granting direct access of foreign airlines into Canada by means of granting of modified sixth freedom or cabotage rights to either AA or to the American government in order to develop competition on domestic air services. As such, the measures that restricted foreign ownership in Canada were instrumental in effectively protecting Air Canada against strong vigorous indigenous competition by smaller airlines that would otherwise have had access to sufficient foreign capital resources, operational and technical expertise and “staying power”. The overall dominance of a large airline in a domestic market implies that active steps need to be taken to stimulate sustainable competition and not only facilitate market entry. Chapter 8 Page 1031

The probability is that, whist the proposals of Air Canada might stimulate a measure of competition from US airlines, that competition will be based on a new bilateral air services agreement of reciprocity that will probably restrict entry and the timing thereof in terms designations and procedures of the two governments (that of the USA and Canada).

In other words, such foreign competition would be of a more restrictive (less competitive) nature in competitive terms than one would expect in situations of a relatively free entry to the market through unilateral action of the Canadian government (which it is entitled to do) and has been adopted by Australia (by means of concept of foreign owned domestic carriers). To eliminate restrictions on ownership of domestic airlines would assist in the capitalisation of smaller airlines that do not have access to government guarantees for the acquisition of aircraft and ensure their “staying power” especially if shareholding of such airlines is also held by substantial overseas airlines with the natural consequences of linking into a larger international network.

8.25.3.4 Regulation of maximum prices on monopoly routes

The experience in Canada has demonstrated that powers to intervene with regard to maximum price regulation of a dominant carrier on monopoly routes had to be exercised as evidenced in 8.18 above. This clearly demonstrates the need for such intervention where no competition exists. As a result, it is recommended that powers to intervene with regard to maximum price regulation of a dominant carrier on monopoly routes be created and be allocated to the Competition Commission. This will facilitate research and increase the ability to maintain air transport policies on a pro-active basis.

The approach advocated in Canada to increase airline data is in a similar rein to that adopted in the USA by means of public disclosure of information on a regular basis.

A similar approach is advocated with regard to South Africa. In addition, it is recommended that origin and destination traffic volumes, as well as the average tariffs for traffic between various airports (routes) be published on a monthly basis in South Africa in order to facilitate research and increase the ability to monitor air transport policies on a pro-active basis.

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Should such publication of traffic volumes, as well as the average tariffs for traffic not be implemented it is recommended that powers be granted to the Air Services Licensing Board to intervene with regard to maximum price regulation of a dominant carrier on monopoly routes had to be exercised as evidenced in 8.19 above.

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8.25.3.5 Interlining

The obligation to interline was established by the Competition Board in South Africa soon after deregulation and appears to have been adhered to subsequently. No legislation or regulations have however been introduced in South Africa in this regard yet. In the European Competition Directorate, interlining became compulsory as a result of a judgement on 26 February 1992 in which a fine of ECU 750 000 was imposed on Aer Lingus PLC relating to a complaint lodged by British Midland to the European Competition Directorate against Air Lingus in April 1990 with regard to the refusal of Air Lingus to interline (proceedings were only initiated in June 1991 and final judgement was issued in February 1992, almost two years after the initial complaint was made). The Canadian government also required that Air Canada interline with smaller carriers.

8.25.3.6 Sale of Canadian Regional Airlines Limited

The government was satisfied with the undertakings made by Air Canada to the Competition Bureau on 21 December 1999 when the company agreed to offer Canadian Regional Airlines Limited for sale at fair market value in order to foster more competition on regional routes, including those served by Air Canada.

It is recommended that the possibility of divestment of SAX and Airlink by SAA/Transnet should be investigated. Such a step could encourage market entry and the development of smaller regional airlines of an independent nature and enable co-operation and interlining with all larger size airlines in South Africa (not only as part of the overall network of SAA).

8.25.3.7 Ongoing monitoring of the airline industry through an independent observer

The Canadian Minister of Transport appointed an independent observer who would monitor, review and assess the effects of airline restructuring on consumers, communities, airports, and on airlines and their employees. This individual was appointed for 18-24 months, with an optional one-year extension if necessary, and report to Parliament through the Minister of Transport. In this report, the observer would make recommendations on, amongst other things, the requirement for, and scope of, any monitoring function after this transition period. Chapter 8 Page 1034

This measure would complement the government’s ongoing monitoring of the airline industry through Transport Canada’s Annual Review and in-house monitoring, Statistics Canada’s reports on data filed by the industry, and through the CTA’s licence monitoring and complaint resolution procedures. In addition, Air Canada agreed that the Commissioner of Competition would review all undertakings made by the company on 21 December 1999 in three years time and determine whether any changes to the undertakings were necessary.

This is perhaps an approach that should be adopted in South Africa at least for so long as the government is the effective controlling shareholder of SAA and state financial aid is provided by means of state guarantees.

It is submitted that the basic approach in South Africa should also be based on relying on the strengthened Competition Act and some pro-competitive regulations as opposed to a full industry regulatory regime that existed in South Africa previously during the currency of the Air Services Act 1949. Regular public disclosure of conditions in the market would promote rational economic decisions by participants in the market as well as the South African government.

As a result of the example set in Canada, it is recommended that the Minister of Transport appoint an independent observer who would monitor, review and assess the effects of airline restructuring on consumers, communities, airports, and on airlines and their employees (in other words all stakeholders) and to report to Parliament through the Minister of Transport.

8.25.3.8 Authority to make temporary cease and desist orders

A cease and desist order is a temporary measure which can be applied to protect competition in the airline industry while the CCB continue with an investigation. The orders would specify what action the dominant airline carrier must take to comply with the law during the period of examination.

This is a particularly important mechanism where the actual implementation of the use of such instrument in the airline industry was first observed in Canada.

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In 5.10 (and in particular in 5.10.7.1) of chapter 5, it was also concluded that that the provisions of the Competition Act in South Africa were also not adequate to timeously address potential concerns in the airline industry. As a result, it would be necessary to provide the Competition Commission or the Competition Tribunal with the authority to make temporary cease and desist orders to intervene quickly in the airline industry in South Africa to prevent injury or irreparable harm to competition much in the same way as has been done in Canada.

As already proposed, the basic approach in South Africa should be based on relying on the strengthened Competition Act and some pro-competitive regulations as opposed to a full industry regulatory regime that existed in South Africa previously during the currency of the Air Services Act 1949.

It is recommended that such exceptional powers to issue a temporary cease and desist order should be adopted in South Africa in order to protect competition in the domestic airline industry. Such legislation to allow the Competition Commission or the Competition Tribunal to issue a temporary order prohibiting a person from operating a domestic service based on certain preconditions (related to concerns about anti-competitive activity). It is essential to note that the negative financial effect of anti-competitive behaviour or an abuse of dominance in the airline industry has an immediate impact on a targeted smaller airline and the nature and extent of such financial effect requires quick intervention to bring such conduct to an end. The time that is currently involved in adjudicating complaints through the normal legal process normally exceeds the time that a smaller airline can withstand the negative financial effect that would be associated with predatory behaviour, as well as actions that constitute an abuse of a dominant position or of an anti-competitive nature, especially under circumstances where the dominant airline is state owned and able to obtain state financial assistance. As such, all the players in the market are not subject to the same financial discipline. With such an approach, the process would include the ability to issue such an order that would be limited to an initial term (but may be renewed for additional periods of time or until review has been adjudicated). Parties subject to an order can challenge it or have it set aside by the Competition Tribunal.

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A temporary order was issued against Air Canada in the CanJet investigation. On 12 October 2000 the Commissioner of Competition stated that this extra ordinary power should be used prudently and only when circumstances fully warranted it.

Following the collapse of Canada 3000 a number of Competition Act amendments with respect to the airline industry were introduced in Canada, to address perceived inadequacies in the Competition Act. These included measures to: • Close the gap that can occur after the expiry of temporary cease and desist orders issued by the Commissioner against a competitor (by permitting extensions of temporary orders) until the Commissioner of Competition has received the relevant information to determine whether to file an application with the Tribunal, and • Permit the Competition Tribunal to assess an administrative monetary penalty (AMP) against an airline, when the Competition Tribunal has issued an order under section 79, the abuse of dominance section of the Act.

The examples relating to enforcement actions in Canada has demonstrated that a dominant carrier will, despite being aware of the government’s intentions to foster competition and being monitored, act against smaller airlines in an aggressive as well as in an anti- competitive manner. As a result of the particular circumstances relating to the airline industry and the very often, permanent damage that could be inflicted within the time that complaints are being investigated, it is necessary to grant the South African Competition Commission or Competition Tribunal the power to issue temporary cease and desist orders. The experience in Canada could serve as a guideline on the nature of the processes relating to such orders.

The experience in Canada demonstrated the importance of temporary cease and desist orders to protect competition in the airline industry. Due to attempts to use the legal system to delay the hearing and final adjudication of complaints and abuse of dominance court actions, it also became necessary to reduce the gap that could exist between the time a temporary order expires and the time the Commissioner is able to bring an application before the Tribunal and to encourage compliance with the abuse of dominance provisions of the Competition Act in the airline industry.

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These measures were necessary in Canada to ensure that the airline market in Canada would be competitive. 8.25.3.9 The objective to promote competition

Certain similarities exit with regard to the air transport market in Canada and in South Africa, notably in the following respects: • A dominant carrier exists (that is state owned in the South African case). • A similar framework for national ownership and control of airlines to that in Canada exists in South Africa (albeit with higher foreign shareholding limits in South Africa), and • Foreign carriers are not currently allowed to fly domestic routes.

The policy relating to foreign ownership and on cabotage were identified as the largest regulatory barriers to entry to the airline industry in Canada (and therefore instruments of protection for local airlines). The same issues are also applicable to South Africa and it is submitted that on the same basis, such factors are likewise the identified as the largest regulatory barriers to entry to the airline industry in South Africa.

As was the case in Canada, a balanced approach needs to be adopted in South Africa both from the angle of transportation interests and specifically from a competition policy perspective, in order to: • Assure the long-term viability of the air transport industry, and • Conserve the advantages of competition to consumers.

There should be an objective to promote competition as a way to achieve the efficient and innovative production and supply of air services and meeting consumers' demands at the lowest possible cost.

This would imply giving the regulator or the competition authorities the role of promoting competition by requiring that regulators minimise restrictions on competition and to provide regulators with the necessary authority “teeth” to implement pro-competitive solutions and cease and desist notices where necessary in order to prevent anti-competitive conduct and the abuse of dominant positions.

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Canada implemented an obligation to regulators in the telecommunications and air transport sectors to promote competition, by requiring them to: • Foster increased reliance on market forces. • Ensure that regulation, where required, are efficient and effective, and • Ensure that anti-competitive conduct and the abuse of dominant positions are prevented.

The Competition Bureau in Canada was required to advise the Minister of Transportation on how to achieve a pro-competitive outcome and that the views of the Competition Bureau would be taken into consideration prior to any decision being taken. The experience of the Competition Bureau in Canada was that in addition to price, as a rule, the track record of dominant firms in most industries in terms of the quality of service or the rate of innovation was questionable. This implies a need for effective safeguards for consumers that competitive market forces should assure a reasonable level of competition in domestic air transport markets.

As a result, it is suggested that measures of a similar nature as adopted in Canada should be adopted in South Africa to correct for the distortions of the free working of market forces as a result of State financial assistance and ownership of SAA, as also applied within the EU.

In order to promote competition in the Canadian airline industry, certain measures were adopted: • Certain enforceable undertakings to enhance competition in a restructured airline industry were provided by Air Canada to the Commissioner of Competition (discussed in 8.10). • Legislation and regulations were passed relating to Canadian airline restructuring (discussed in 8.11 and 8.12).

8.25.3.10 Undertakings with regard to the merger between Air Canada and Canadian Airlines

Certain enforceable undertakings were required by the Canadian government and Competition Commissioner for approval of the merger between Air Canada and Canadian

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Airlines as a result of the resulting dominance of Air Canada in the domestic market of Canada. To the extent that alliances between SAA, SAX and SAL is based on consolidating the network effect of such airlines and the economies of scope of loyalty schemes of frequent flyer schemes, corporate discount schemes and travel agent overriding commission schemes it is submitted that such alliances has the same effect as a merger of such airlines and that certain conditions be set to mitigate the anti-competitive effects of such alliance agreements.

8.25.3.11 Certain conduct regarded as anti-competitive in legislation and regulation in terms of abuse of dominance provisions of the Canadian Competition Act

Certain conduct was defined by regulation as anti-competitive when carried out by a dominant airline carrier as identified in 8.12.2. The abuse of dominance provisions provided broad powers to the Competition Tribunal that included the ability to make an order: • Prohibiting a respondent firm or firms from engaging in the practice of anti- competitive acts, and • Directing any such actions, including the divestiture of assets or shares, as are reasonable and necessary to overcome the effects of the practice of anti-competitive acts in cases where the Competition Tribunal concluded that such an order may not be adequate to restore competition.

The list of anti-competitive practices was discussed in more detail in a document, Guidelines on Enforcement of "Abuse of Dominance Provisions" of the Competition Act that was published by the Competition Bureau with respect to sections 78 and 79 on 1 August 2001.

In 8.12.5 the unlawful engagement in a practice of anti-competitive acts were identified that included: • Operating/Increasing Capacity at Fares Below Avoidable Cost discussed in 8.12.5.1. • A new Avoidable Cost Test was introduced in the Canadian Competition Act to cater for the needs of the airline industry as identified in 8.12.5.1.1. • Certain exclusionary conduct was defined as anti-competitive acts in 8.12.5.2 that included: o Pre-empting airport facilities or services as noted in 8.12.5.2.1.

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o Withholding the respecting take-off and landing slots as noted in 8.12.5.2.2 • Altering schedules, networks, or infrastructure for the purpose of disciplining or eliminating a competitor or impeding or preventing a competitor's entry into, or expansion in, a market as noted in 8.12.5.2.3. This would include alterations of the schedule the dominant carrier subsequent to the interline arrangement in a way that made the rival's service unprofitable. • The denial of access or refusal by such a person to supply such facilities or services on reasonable commercial terms that are essential to the operation in a market of an "air service" was defined as a form of exclusionary conduct representing an anti- competitive-act was noted in 8.12.5.3. The facilities and services may include, but are not limited to, take-off and landing slots, interline arrangements, airport gates, loading bridges, counters and related airport facilities, maintenance services, and baggage handling infrastructure, equipment and services. This would include raising a rival's costs.

• With regard to marketing conduct of airlines two other anti-competitive acts were identified in 8.12.6: o Using commissions, incentives or other inducements to sell or purchase its flights for the purpose of disciplining or eliminating a competitor or impeding or preventing a competitor's entry into, or expansion in, a market. o Using a loyalty marketing programme for the purpose of disciplining or eliminating a competitor or impeding or preventing a competitor's entry into, or expansion in, a market.

In addition to the anti-competitive acts defined for the airline industry by the regulations, section 78 of the Canadian Competition Act provides a non-exhaustive, illustrative list of anti-competitive acts as follows: • Margin squeezing by a vertically integrated supplier against a customer-competitor. • Acquisition by a supplier of a customer to foreclose a competitor. • Freight equalisation on a competitor's plant to eliminate or impede competition. • Selective use of fighting brands to discipline or eliminate a competitor. • Pre-emption of scarce facilities or resources required by a competitor. • Buying up products to prevent price erosion.

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• Adopting incompatible specifications to prevent entry or eliminate a competitor. • Requiring or inducing suppliers to sell only or primarily to certain customers. • Selling articles below acquisition costs to discipline or eliminate a competitor. 599)

From a timing perspective, the developments in Canada took the regulatory developments in the USA with regard to the proposed policy relating to unfair exclusionary conduct in the air transportation industry (referred to in 7.6.3 chapter 7) further. Due to the urgency of the situation in Canada a range of regulatory steps were taken and implemented. As probably was expected, Air Canada abused its dominance following the merger and the Competition Authorities issued cease and desist orders to protect competition and had to challenge Air Canada in relation to operating and increasing capacity at fares below avoidable cost. This issue is discussed in section 8.15.12. Legal action tested the working of the framework that was implemented in Canada. As a result, the developments in Canada could act as a guide for South Africa in terms of measures that need to be taken to foster competition in the air transport industry.

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