FEDERAL COURT OF AUSTRALIA Austrac Operations Pty Ltd v State of New South Wales [2003] FCA 1013 PRACTICE & PROCEDURE – preliminary discovery – whether reasonable cause to believe that applicant has or may have the right to obtain relief pursuant to the Trade Practices Act 1974 (Cth) – objective test TRADE PRACTICES – market power – definition of market – whether substantial degree of market power in coal freight rail market and grain freight rail market – whether taking advantage of market power Trade Practices Act 1974 (Cth) ss 46, 82, 87 Freight Rail Corporation (Sale) Act 2001 (NSW) s 15 Federal Court Rules O 15A r 6 Australian Competition and Consumer Commission v Australian Safeway Stores Pty Ltd (2003) 198 ALR 657 cited Boral Besser Masonry Ltd v Australian Competition and Consumer Commission (2003) 195 ALR 609 cited Dowling v Dalgety Australia Ltd (1992) 34 FCR 109 cited Optus Communications Pty Ltd v Telstra Corp Ltd [1999] FCA 47 cited AUSTRAC OPERATIONS PTY LTD (IN LIQUIDATION) & ORS v STATE OF NEW SOUTH WALES & ANOR N 590 OF 2003 EMMETT J 5 SEPTEMBER 2003 SYDNEY IN THE FEDERAL COURT OF AUSTRALIA NEW SOUTH WALES DISTRICT REGISTRY N590 OF 2003 BETWEEN: AUSTRAC OPERATIONS PTY LTD (In Liquidation) ACN 061 696 580 FIRST APPLICANT AUSTRAC HOLDINGS PTY LTD (Subject to deed of company arrangement) ACN 076 803 079 SECOND APPLICANT AUSTRALIAN TRACTION CORPORATION PTY LTD (Subject to deed of company arrangement) ACN 061 696 697 THIRD APPLICANT AND: STATE OF NEW SOUTH WALES FIRST RESPONDENT FREIGHT RAIL CORPORATION (t/as FreightCorp) SECOND RESPONDENT JUDGE: EMMETT J DATE OF ORDER: 5 SEPTEMBER 2003 WHERE MADE: SYDNEY THE COURT ORDERS THAT: 1. the application be dismissed; 2. the applicants pay the respondents' costs. Note: Settlement and entry of orders is dealt with in Order 36 of the Federal Court Rules. IN THE FEDERAL COURT OF AUSTRALIA NEW SOUTH WALES DISTRICT REGISTRY N590 OF 2003 BETWEEN: AUSTRAC OPERATIONS PTY LTD (In Liquidation) ACN 061 696 580 FIRST APPLICANT AUSTRAC HOLDINGS PTY LTD (Subject to deed of company arrangement) ACN 076 803 079 SECOND APPLICANT AUSTRALIAN TRACTION CORPORATION PTY LTD (Subject to deed of company arrangement) ACN 061 696 697 THIRD APPLICANT AND: STATE OF NEW SOUTH WALES FIRST RESPONDENT FREIGHT RAIL CORPORATION (t/as FreightCorp) SECOND RESPONDENT JUDGE: EMMETT J DATE: 5 SEPTEMBER 2003 PLACE: SYDNEY REASONS FOR JUDGMENT 1 I have before me an application under O 15A r 6 of the Federal Court Rules. The application is brought by Austrac Operations Pty Ltd, Austrac Holdings Pty Ltd and Australian Traction Corporation Pty Ltd (together 'Austrac'). The respondents are the State of New South Wales ('the State') and Freight Rail Corporation ('FreightCorp'). FreightCorp is a corporation sole by reason of the operation of s 15(1)(b) of the Freight Rail Corporation (Sale) Act 2001 (NSW). 2 Order 15A r 6 provides that where: (a) there is a reasonable cause to believe that an applicant has or may have the right to obtain relief in the Court from a person whose description has been ascertained; (b) after making all reasonable inquiries, the applicant has not sufficient information to enable a decision to be made whether to commence a proceeding in the Court to obtain that relief; and (c) there is reasonable cause to believe that that person has or is likely to have or has had or is likely to have had possession of any document relating to the question whether the applicant has the right to obtain the relief and that inspection of the document by the applicant would assist in making the decision; the Court may order that that person make discovery to the applicant of any document of the kind described in par (c). 3 In 1996, the New South Wales rail industry was restructured by dividing the functions of the State Rail Authority of New South Wales into four independent business entities. Those entities included Rail Access Corporation (as it then was), which owns the State's rail infrastructure and is responsible for managing it and providing access to rail operators on the network, and FreightCorp, which owned and maintained its own rolling stock and locomotives and was responsible for freight operations. During the period from 1996 to 2002, FreightCorp continued to provide rail freight services within New South Wales. 4 In October 1997, Austrac commenced transporting containerised freight from the Riverina to certain ports. Austrac closed their rail freight operations in August 2002. A liquidator was appointed to Austrac Operations Pty Ltd in August 2002; Austrac Holdings Pty Ltd and Australian Traction Corporation Pty Ltd entered into deeds of arrangement in December 2002. 5 Austrac contends that there are relevantly three markets relating to the carriage of freight in New South Wales. One is the market for the carriage of coal (' the coal freight rail market'), one is the market for the carriage of grain ('the grain freight rail market') and one is the market for the carriage of containers containing freight from various areas, including the Riverina area ('the Riverina container market'). 6 Austrac asserts that there is reasonable cause to believe that it may have the right to obtain relief in the Court under the Trade Practices Act 1974 (Cth) from the State and FreightCorp. Specifically, Austrac says that it believes that it has a right to relief under s 82 and s 87 of the Trade Practices Act pursuant to alleged contraventions of s 46. Section 46(1) relevantly provides that a corporation that has a substantial degree of power in a market must not take advantage of that power for the purpose of eliminating or substantially damaging a competitor of the corporation in that or any other market or deterring or preventing a person from engaging in competitive conduct in that or any other market. 7 Austrac's contention is that it may have a cause of action which might be summarised as follows: * FreightCorp has, or had at the relevant time, a substantial degree of power in both the coal freight rail market and the grain freight rail market in New South Wales; * FreightCorp took advantage of that power by providing freight services in the Riverina container market at a price below cost by the employment of profits derived from the coal freight rail market and the grain freight rail market or from subsidies provided by the State in relation to the grain freight rail market; · FreightCorp took that action for the purpose of eliminating or substantially damaging Austrac, a competitor of FreightCorp in the Riverina container market. 8 The respondents accept that Austrac has made all reasonable inquiries such as are referred to O 15A r 6(b). The respondents also accept that there is reasonable cause to believe that they have, or are likely to have, possession of documents relating to the question of whether Austrac has the right to obtain relief under the Trade Practices Act in respect of the asserted cause of action and that inspection of those documents by Austrac would assist in making the decision referred to in r 6(b). However, the respondents dispute that there is reasonable cause to believe that Austrac has any right, or may have any right, to obtain relief in the Court. The respondents also dispute that, even if there were a reasonable cause to believe that Austrac may have such a right, Austrac does not have sufficient information for a decision to be made whether or not to commence proceeding in the Court to obtain that relief. 9 The application describes nine categories of documents, discovery of which is sought. After argument, it was accepted that, if the other requirements for the establishment of a right to an order under r 6 are made out, then the documents referred to in prayer 1 of the application would be documents that fall within r 6(c). It is, therefore, not necessary for me to describe those documents in any detail. 10 There is no dispute as to the nature of the task that arises under r 6(a). The words, 'where there is reasonable cause to believe that the applicant has or may have the right to obtain relief' are not satisfied by mere assertion. The belief requires more than mere suspicion or conjecture. On the other hand, it is not necessary for an applicant to establish even a prima facie case. It is necessary, however, for the applicant to show objectively that there is reasonable cause for the relevant belief. It is not necessary to demonstrate whether or not the applicant has the belief. 11 It seems to me that an appropriate approach in relation to an application under r 6 based on s 46 of the Trade Practices Act is to examine the various elements of s 46 in order to determine whether there is reasonable cause to believe that each of the necessary elements exists. The first element is whether or not FreightCorp has a substantial degree of power in the relevant markets. That issue, of itself, has sub-issues; first of all, whether or not there are markets, as asserted by Austrac. The notion of market, of course, is artificial. It is not necessarily a physical manifestation. Rather, it is a construct by reference to which conduct is proscribed: see Dowling v Dalgety Australia Ltd (1992) 34 FCR 109 at 132; Australian Competition and Consumer Commission v Australian Safeway Stores Pty Ltd (2003) 198 ALR 657 at 714 [293]. 12 For the purposes of this application, I do not understand the respondents to have contested that there is at least a reasonable basis for a belief of the existence of the markets contended for by Austrac. However, the respondents do dispute that FreightCorp had a substantial degree of power at the relevant time in the coal freight rail market or the grain freight rail market. It is not suggested by Austrac that FreightCorp had a substantial degree of power in the Riverina container market. 13 Market power may be described as the ability of a firm to raise prices above supply cost without rivals taking away customers in due time, supply cost being the minimum cost an efficient firm would incur in producing the product. The market power of a supplier may be defined in terms of its ability to raise prices above supply costs without losing business to another supplier. Pricing may not be the only aspect of market behaviour, however, that manifests power. Other aspects may be the capacity to withhold supply or to decide the terms and the conditions, apart from price, upon which supply will take place. However, pricing is ordinarily regarded as the critical test and it is pricing behaviour that is the relevant conduct in many cases. The existence of such a power may result in a variety of circumstances. A large market share may or may not give power. The presence or absence of barriers to entry into a market will ordinarily be vital. 14 Financial strength is not of itself market power although, if a firm has market power, its financial resources might be part of the explanation of that power. Thus, the financial ability to survive a price war is not market power or a manifestation of characteristics that give market power if, when the price war is over, the market is still highly competitive. Power in a supplier ordinarily means the ability to put prices up, not down, but, if a market is not competitive, and a firm puts prices down seeking to eliminate a potential rival in the expectation it will thereafter be in a position to raise prices without competitive restraint, its ability to act in that manner may reflect the existence of market power: see Boral Besser Masonry Ltd v Australian Competition and Consumer Commission (2003) 195 ALR 609 at 635 [136]-[138]. 15 There is evidence before me of the existence of barriers to entry into freight rail markets in New South Wales. A new market entrant into the Australian rail freight industry might be seen to face significant and increasing barriers to entry. The industry is capital intensive. The evidence suggests that about one dollar of balance sheet assets is required to generate one dollar of revenue, utilising a conventional new asset operating structure. An entrant into the market would require locomotives and rolling stock. New locomotives of the relevant power could cost in the vicinity of $3,000,000 to $4,000,000, each with long lead times on delivery. Standard freight cars cost $100,000 to $120,000 new. Thus, the capital cost of a typical new thirty car train carrying about 1500 tonnes of freight is in the region of about $7,000,000. Such a unit could generate about $10,000,000 of revenue per annum. 16 Access to track infrastructure is available but is restricted by stringent quality and safety standard licensing regimes administered by the Department of Transport of the State. For approval, demonstrated technical capacity is required. Such an approval is relatively lengthy, with applicants typically experiencing uncertainty and long delay. In New South Wales, each applicant wishing to run train services must also apply for a schedule path from the Rail Infrastructure Corporation (the successor to Rail Access Corporation) which, as I have said, owns and controls access to all tracks and associated public infrastructure. The allocation of new schedule paths into Sydney is constrained by limited track capacity and the policy of preference for passenger trains. New entrants could not generally expect path timetables at times which are operationally convenient. In addition, crews are required to be licensed with local knowledge capacity. Training of crews takes time. 17 There is only a limited range of options in New South Wales in relation to locomotive servicing. The development of new work shops, while possible, is constrained by the availability of level ground alongside railway tracks at natural service points and the requirement for additional capital investment. Efficient maintenance, however, is an important competitive element as it accounts for about one fifth of all operating costs, as well as impacting locomotive availability. 18 By the end of 2002, FreightCorp retained approximately 98 per cent of the coal freight rail market and about 90 per cent of the grain freight rail market. The decrease in its share of the grain freight rail market is substantially explained by the entry of two Victorian operators who obtained bulk wheat haulage contracts from the Australian Wheat Board, commencing in 1999 and 2000. 19 The third factor, relied upon by Austrac as giving rise to a conclusion of market power on the part of FreightCorp, is the provision by the State of subsidies to FreightCorp in connection with its rail freight operations. During the year 2000, for example, several agreements were entered into between the Director General of the State's Department of Transport, on the one hand, and FreightCorp, on the other, relating to the provision of subsidies. Those agreements may be typified by the terms of an agreement entitled 'CSO Funding Agreement – Grain' made on 24 November 2000. CSO is defined as meaning 'community service obligation'. 20 The CSO Funding Agreement recites that it is the objective of the Government of New South Wales to encourage the transfer of grain products normally carried by road to be carried by rail and that sufficient rail freight capacity be available to meet the grain haulage task during periods of above average harvest. It then recites that, in pursuance of the objectives of the Government, FreightCorp had been requested to provide cost efficient rail freight services at rates that would be otherwise unsustainable and to provide capacity above commercially sustainable levels in return for a payment pursuant to the community service obligations of the Government of New South Wales. The parties acknowledged that it was the objective of FreightCorp to develop the grain rail freight business by increasing customer revenue and/or reducing the cost of providing the rail freight services and, in the process, reduce future CSO funding. 21 Apart from the CSO Funding Agreement relating to grain, agreements were also entered into in relation to the transfer of general freight products under the name 'Portlink', the transfer of general freight products to and from the north coast of New South Wales and the transfer of petroleum products. The scheme of the agreements is generally similar. It involves, in effect, the provision by the State of a subsidy to FreightCorp to enable it to provide freight services at a price lower than would need to be charged on a commercial basis. 22 Austrac contends that those three factors, that is market share, the size of barriers to entry and the existence of the subsidy, give rise to an inference that FreightCorp has a substantial degree of power in the two markets. There is no subsidy in relation to the coal freight rail market, and there are subsidies in relation to other areas of freight coverage than grain. No assertion, however, is made of market power in any market other than the coal and grain freight rail markets. 23 There is no material before me from which an inference could be drawn that FreightCorp has raised praises in either the coal freight rail market or the grain freight rail market above supply cost without losing business. Nor is there any material from which an inference can be drawn that FreightCorp has withheld the supply of services in either of those markets, or to have imposed particular terms and conditions, apart from price, upon which it provides services. There is no material from which any inference could be drawn that FreightCorp has engaged in exclusive dealing, for example, in relation to the provision of freight services. 24 However, the fact that it has not done those things is not, of itself, decisive as to whether or not it has the power. Power may exist without it being exercised. Nevertheless, in the context of s 46, although the question of the existence of power and the taking of advantage of power are separate issues, they are interrelated. In order to determine whether or not there has been a taking of advantage of power in a market, one must determine what the power is. That is to say, one cannot conclude that someone has taken advantage of a power unless one has first concluded that the power exists. 25 The material before me way well be equivocal as to whether or not a substantial degree of power is held by FreightCorp in the two relevant markets. One might lean towards the notion that FreightCorp's market share and the significant cost of entry to the market, which is a substantial barrier to entry, might point towards the existence of power, although, to the extent that there is any evidence, prices in the two markets have in fact declined during the relevant period. That rather suggests that there is a competitive element, or that there is some other outside element. One possible outside element is the strength of the customers of FreightCorp, particularly coal mining interests and wheat and grain boards that have monopsonistic power, at least in relation to the export of grain from Australia. 26 I do not, however, see the subsidies provided by the State to FreightCorp as an element going to the existence of market power. That, it seems to me, is simply an aspect of the financial strength of FreightCorp. That is to say, in so far as FreightCorp, at the relevant time, was a statutory corporation of the State, its owner, the State, was prepared to provide it with business, by subsidising freight services to be provided to residents of New South Wales. Just as a private firm may raise capital from its shareholders, so a statutory corporation may have financial strength by reason of the preparedness of the State to contribute to its capital or to provide it with an inducement to supply services at a price below cost. 27 Austrac, at one level, put its case on the basis that, where a firm with a substantial degree of market power derives monopolistic profits from the exercise of that power in one market, and then uses the funds so generated for a purpose referred to in s 46(1), there may be a contravention of s 46. That may be so, although I have reservations about that: see Optus Communications Pty Ltd v Telstra Corp Ltd [1999] FCA 47 at [8]-[10]. I am not satisfied, however, that the material before me is capable of giving rise to a reasonable cause for belief that there has been any exercise of such power. There is no evidence that there has in fact been a charging of monopolistic prices by FreightCorp in the two relevant markets. 28 Austrac then concentrated its contentions on the CSO subsidies. It was put that the existence of the agreements for the provision of the subsidy is in some way an aspect of market power. I have already indicated that I do not accept that the existence of the subsidy is an aspect of market power. It is no more than part of the financial resource of FreightCorp. In those circumstances, it could not be said that there is any reasonable cause for belief that, even if FreightCorp has applied subsidies received from the CSO funding agreements to enable it to reduce its prices in the Riverina container market, the use of the funds in that way is a taking advantage by FreightCorp of any aspect of market power in the grain freight rail market. It certainly could not apply in relation to the coal freight rail market since there is no CSO funding agreement in relation to the haulage of coal. 29 There is some material from which a reasonable belief might arise that some part of the grain subsidy has been applied in relation to the Riverina container market. The material is almost equivocal but, on balance, it may justify a sufficient basis for a belief such as would satisfy r 6(a). 30 The evidence before me includes the executive summary of an interim report prepared by Booz Allen & Hamilton in December 1999 for the State's Department of Transport. The report is of a review of competitive neutrality in rail freight in New South Wales. One of the elements examined by the report, according to the executive summary, is the impact of the CSO subsidies on competitive neutrality, so far as FreightCorp is concerned. The summary notes that an exclusive contract on commercial terms with a purchaser of freight services should not, on face value, contravene competitive neutrality principles. However, if subsidies are inappropriately applied and undermine commercial markets, there would be cause for concern. Difficulties would arise where subsidies fund rail prices below the efficient cost of supply in markets where the market price would support an efficient rail operator. In such a case, the recipient of a subsidy could under-price in the face of the rail competition with financial support from the subsidy. 31 The summary indicates that there is some evidence that a small proportion of FreightCorp's subsidies from the CSO funding agreements may be impacting upon commercial rail markets. The summary notes that rates in some CSO-supported industrial and rural export container markets appeared to have adjusted downwards simultaneously with the introduction of rail competition, so far as FreightCorp is concerned. Specifically, it records that private operators are competing for services out of the Riverina and in the metropolitan container movements. Those markets attracted about 5 per cent of CSO subsidy payments in 1998/1999. The summary referred to difficulties for the Department of Transport in establishing which markets were currently commercial rail markets or potentially could be commercial rail markets with effective rail competition. 32 The summary is something more than a mere straw in the wind. It would, I consider, justify a conclusion that, if the other elements necessary to establish the cause of action relied on were present, there would be reasonable cause to believe that CSO subsidies may have been applied in relation to the Riverina container market. 33 There is no material at all as to the actual purpose of FreightCorp in its pricing policy in the Riverina container market. There is evidence that would justify a conclusion that there is reasonable cause for belief that the prices charged by FreightCorp from 1996 to 2002 in the Riverina container market have reduced. The material would also justify a conclusion that there is reasonable cause for belief that FreightCorp's pricing is significantly less than its costs in that market. 34 Calculations in evidence suggest that FreightCorp's pricing may be about 33 per cent less than long run avoidable cost, which is defined as all costs except fixed overheads, grain capacity and weighted average cost of capital, a component of capital costs. The material also suggests that FreightCorp's pricing is about 54 per cent less than fully distributed costs. In the absence of anything further, it may be that an inference can be drawn that the only reason for pricing freight charges in the Riverina container market at such a significant amount less than cost recovery was to damage or eliminate competition. There is, however, no material relating to the question as to the extent to which, once competition were eliminated, there would be any capacity to recover the losses. 35 Section 46(7) of the Trade Practices Act provides that a corporation may be taken to have taken advantage of its power for a purpose referred to in s 46(1) notwithstanding that, after all of the evidence has been considered, the existence of that purpose is ascertainable only by inference from the conduct of the corporation. Thus, if the only possible explanation for the pricing policy was to damage Austrac, an inference may be capable of being drawn that that was the purpose for the purposes of s 46(1). 36 No attempt has been made on the part of the respondents to adduce evidence at this stage to rebut any inference that might be drawn. It may be, therefore, that, if on a careful analysis of all of the material, it was shown that there was pricing at the level suggested by material before me and there was no explanation for that, the relevant inference would be capable of being drawn. That being so, I would be disposed to conclude that, if the other elements of the cause of action could be shown to the necessary degree required by r 6(a), the element of purpose would be satisfied to that degree. 37 However, for the reasons that I have indicated, I do not consider on the material before me that there is reasonable cause to believe that, even if it has a substantial degree of power in the markets alleged, FreightCorp has taken advantage of that power. I do not consider that the material enables any conclusion to be drawn that there may be a power to increase prices, or to impose terms, or to reduce supply of which advantage has been taken within the meaning of s 46(1). 38 It follows, in my opinion, that on the basis of the material presently before me, the application should be dismissed. I certify that the preceding thirty-eight (38) numbered paragraphs are a true copy of the Reasons for Judgment herein of the Honourable Justice Emmett. Associate: Dated: 24 September 2003 Counsel for the Applicants: J E Griffiths SC with N L Sharp Solicitor for the Applicants: Phillips Fox Counsel for the Respondents: J S Hilton SC with M J Leeming Solicitor for the Respondents: Gilbert + Tobin Date of Hearing: 4 and 5 September 2003 Date of Judgment: 5 September 2003