Bronwyn Howell highlights the important legal principles on which the Crafar Farms case depended, and why they are important

By Bronwyn Howell

Conceptually, the analytical processes to support decisionmaking appear straightforward. In practice, however, this is rarely the case: almost all decisions are made under conditions of uncertainty.

Whilst there is always some doubt about what will occur if a particular decision is taken (typically accounted for with sensitivity analysis), the counterfactual is also forward-looking – and so it cannot be taken for granted that the status quo at the time a decision is made will prevail unchanged into the future.

These features of decisionmaking were highlighted in February, when the High Court overturned the initial decision made by Ministers Jonathan Coleman and Maurice Williamson under the Overseas Investment Act 2005 to approve Pengxin Corporation’s purchase of the Crafar farms.

Justice Miller found that, in advising the Ministers, the Overseas Investment Office (OIO) had wrongly used the status quo of the Crafar farms remaining in their current dilapidated state as the counterfactual against which to assess Pengxin’s proposal. As the farms were in receivership and sale was inevitable, Justice Miller considered that in a forward-looking counterfactual any purchaser would make the investments necessary to bring the farms back into full production.

Thus, he determined that the sums proposed by Pengxin for this purpose could not be considered part of the benefits brought to the New Zealand economy by sale to a foreign interest.

This led to the much publicised conclusion that the benefits of the deal had been vastly overstated, and the decision being returned to the Ministers for reconsideration.

When reconsidering using the forward-looking counterfactual for the sale of the farms to a New Zealand purchaser, the OIO found (and the Ministers agreed) that the Pengxin offer would still lead to substantial and identifiable benefits to New Zealand; and approval to proceed was granted on 20 April.

However, the case has raised some interesting questions about what the appropriate counterfactual should be in cases where Ministers or other appointed decisionmakers have the power to grant or decline permission for commercial ventures to proceed.

The factual is unequivocably what will occur if approval is given. But is the (forward-looking) counterfactual ‘what could reasonably have been expected to occur if the transaction in question not been proposed’ as suggested by Justice Miller in the Crafar farms case, where the counterfactual to the Pengxin proposal was taken as an alternative (New Zealand) purchaser making an offer?

Or is it ‘what would ensue if approval for the transaction in question is declined’?

The distinction is not trivial.

The crux of the matter is whether the decision itself will alter expectations regarding future transactions: in which case the appropriate counterfactual is what will occur if permission for the proposed transaction is declined. The Pengxin/Crafar example again illustrates this.

Pengxin’s offer for the Crafar farms was nearly forty million dollars higher than the price indicated by the consortium seeking to have the Ministers’ approval overturned.

Presumably this would be the best offer for the farms from a New Zealand purchaser.

As Pengxin tendered for the farms in an open-sale process, its price reflects the value of the business to the highest-valuing prospective owner.

If the Ministers declined the Pengxin offer, then the business would be sold at a lower price to a lower-valuing (New Zealand) owner.

This would have a consequential depressing effect on the market value of all similar businesses (market values having adjusted upwards in response to information about Pengxin’s price).

Although lower-priced farms might be attractive to prospective buyers, a decrease in values is costly to all existing farm owners: they now anticipate receiving less when selling and can borrow less for capital improvements.

Such losses would be taken into account if the counterfactual was ‘declining the transaction’.

By comparison, under Justice Miller’s counterfactual (what would have occurred if the Pengxin bid was never made), any increase in overall market values arising from selling to the highest-valuing prospective owner will be omitted from consideration. (This is because the Overseas Investment Act explicitly excludes any price premium paid by a foreign purchaser from consideration in the ‘factual’ case.)

Consequently, the benefits arising will likely be substantially understated if this counterfactual is chosen.

As the Crafar farms case shows, great care must be taken when selecting a counterfactual. Getting it wrong could be very costly.

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This article was first published by the ISCR in the July 2012 issue of their "Competition and Regulation Times". It is republished here with permission.

The ISCR website is here » and a .pdf version of their Issue #38 is here »

For more detail, see Comments on the Crafar Farms Counterfactual (available at www.iscr.org.nz).