Thursday, May 2, 2013

Competition Law Risks: Non-Compete Clauses in M&A Transactions – Part 1


[The following post is contributed by Soumya Hariharan, who is a Foreign Lawyer in Rodyk & Davidson LLP’s Corporate and Competition Law Practice in Singapore. Soumya obtained her BSL.LL.B degree from ILS Law College and has an LL.M degree (Corporate & Financial Services Law) from the National University of Singapore.

These views are personal.

In this first part, Soumya provides a broad overview of competition law risks arising from non-compete clauses and how they have been dealt with by the European Commission]

Competition law regulators have been actively investigating non-compete clauses in Merger and Acquisition (“M&A”) transactions.[1] Most jurisdictions recognize that certain contractual restrictions in the form of non-compete clauses may be directly related and necessary for the successful implementation of a merger. However there are times when non-compete clauses incorporated in M&A transactions and joint ventures carry the risk of infringing competition law.

Non-compete clauses that carry competition law risks can delay deal timelines and affect the transaction from obtaining a favorable clearance from the competition law regulator. Companies stand a risk of investigation by the competition law regulators and financial penalties can be imposed for illegal non-compete clauses.

This series of posts aims to give a broad overview on how non-compete clauses in M&A transactions carry certain competition law risks, in light of recent decisions rendered by the European Commission (“EC”) and the Competition Commission of India (“CCI”). The article also highlights the importance of drafting non-compete clauses in compliance with competition law.

Ancillary Restraints and Non-Compete Clauses

Non-compete clauses are usually negotiated in most M&A transactions and it is fairly common for the Acquirer to require non-compete obligations from the Vendor. To effect a successful transaction, certain restrictions on competition between the Parties are required to the extent that they are directly related and necessary for the implementation of the merger.

Such restrictions, negotiated by the Parties are referred to as “ancillary restraints” in competition law parlance. The most common examples of ancillary restraints include non-compete clauses, license agreements, purchase and supply agreements.

Usually it is standard business practice to incorporate non-compete obligations for the effective implementation of the proposed merger that allows the Acquirer to obtain full value from the acquired assets including tangible and intangible assets such as know-how and goodwill.  In Europe, the 2005 Notice on restrictions directly related and necessary to concentrations (the “Ancillary Restraints Notice”) provides clarity and guidance on the treatment of non-compete clauses.  

The EC has been scrutinizing non-compete clauses that may result in a breach of competition law, i.e. cases where the non-compete clause is not directly related and necessary for the implementation of the merger.

Two recent decisions of the EC provide further clarity as to how it interprets non-compete clauses.  One of the cases deals with an illegal non-compete entered into by two telecom operators, where the non-compete clause operated as a market sharing agreement. The second case deals with a non-compete clause that was operative post the termination of the joint venture which was considered excessive in scope and duration by the EC. The following cases serve as effective guidance to those companies that plan to incorporate non-compete clauses in their M&A transactions.

Telefónica and Portugal Telecom[2]

In 2011, the EC investigated two large telecom players Telefónica and Portugal Telecom in relation to a non-compete clause in the context of Telefónica’s acquisition of sole control of the Brazilian mobile operator Vivo. They were fined EUR 79 million for a breach of Article 101 of the Treaty on the Functioning of the European Union (TFEU) which prohibits anti competitive agreements.[3]

Article 101 prohibits all agreements, decisions and practices between undertakings and concerted practices which may affect trade within EU member states and which have as their object or effect the prevention, restriction or distortion of competition within the EU market.  

In 2010, Telefónica acquired sole control of Vivo which was until then jointly owned by both Telefónica and Portugal Telecom. The parties entered into a non-compete clause in their purchase agreement as a part of the acquisition which required Telefónica and Portugal Telecom not to compete with each other in Spain and Portugal from the end of September 2010.

The EC held that by implementing the non-compete clause, Telefónica and Portugal Telecom deliberately agreed to stay out of each other’s home markets rather than competing with each other.  The parties terminated the non-compete agreement in early February 2011 nearly four months into operation by offering commitments to the EC.  It is useful to note that in this case, the EC commenced investigations on its own initiative and fined Telefónica and Portugal Telecom notwithstanding the short duration of the infringement.

Siemens and Areva[4]

In 2001 Areva and Siemens established a joint venture Areva NP, which combined their activities in nuclear technology and nuclear power plants. The Shareholders Agreement for the joint venture included a non-compete clause for a period of 11 years from the termination of the joint venture. The non-compete clause covered the core nuclear services of the joint venture as well as non-core products and services in relation to which the joint venture was not active. In 2009, Siemens withdrew from the joint venture and Areva acquired sole control over the joint venture.

In 2010 the EC opened an investigation over the competition concerns relating to the non-compete clause. The EC adopted a preliminary decision in 2011 that Siemens and Areva had infringed Article 101 due to the non-compete obligation being excessive in scope and duration. According to the EC the scope of the non-compete clause was excessive because it prevented Siemens from competing in markets where Areva NP was only a re-seller of Siemens products.

To address the concerns of the EC both Siemens and Areva offered commitments, to limit the scope of the non-compete clause to Areva NP’s core products and services for a period of three years after Siemens exit from the joint venture. Under the commitments the non-compete obligations would only apply to certain core products and services offered by the joint venture company solely controlled by Areva.

- Soumya Hariharan




[1] The European Commission investigated Telefónica and Portugal Telecom in 2011 and investigated Areva and Siemens in 2010.
[2] See Press Release dated 23/01/2013 http://europa.eu/rapid/press-release_IP-13-39_en.htm
[3] The European Commission fined Telefonica and Portugal Telecom EUR 66894000 and EUR 12290000 respectively for agreeing not to compete with each other.
[4] Case COMP/39736 dated 18/06/2012

4 comments:

vswami said...

To Share random thoughts:

“....However there are times when non-compete clauses incorporated in M&A transactions and joint ventures carry the risk of infringing competition law....”
“...The article also highlights the importance of drafting non-compete clauses in compliance with competition law....”
The subject of the write-up is prima facie one of those several of the kind falling under a highly specialized category. That is one on which not everyone , even a concerned leading business house or its advising expert / law professional , could reasonably be expected to be so equipped as to understand and appreciate the vagaries of the legal requirements; in particular, seriousness or otherwise of the inherent exposures likely to be faced with under the law on competition, by reason of a non-compete clause (imposing an ‘ancillary restraint’) in a contract agreement (s) evidencing the referred type of transaction (s) .
Nonetheless, even as a novice, one may have a point of basic doubt to raise, calling for clarity, having in mind the generic principles of the law on contract. That is, in a case in which there is any such objectionable clause, but the parties, for practical reasons, do not choose to, and hence raise no objection or litigate on . The doubt is, - is it still within the powers of competent authority (EC or CCI) to decide and rightly initiate and pursue any investigation of the type in contemplation.
(unedited; but believe the point of doubt raised soliciting clarification has been made clear/in any event, not difficult to be understood by a law expert)

vswami said...

To dilate (on a second thought):
In short, the point of doubt is this: - Will EC or CCI be well within its powers to initiate any action/investigation even if it is not approached by either party to the contract agreement claiming to be aggrieved by reason of a non-compliance with the agreed terms ?
What, in the writer's personal opinion,is the strict legal position, or a better view, even if it entails any far reaching effect/unsavory consequence,remotely or otherwise, from the angle of ‘public interest’ in its commonly acceptable/accepted sense) ?

vswami said...

Add-on:
“... In Europe, the 2005 Notice on restrictions directly related and necessary to concentrations (the “Ancillary Restraints Notice”) provides clarity and guidance on the treatment of non-compete clauses.....”
May be so; but then, >
Any common reader of a financial /economic daily or journal may remember to have read about ‘Tobin Tax’; but many may not have necessarily read or come to know about the controversy raging within the European community itself on the propriety/legitimacy , or otherwise of the levy.
As per the report @ http://www.guardian.co.uk/law/2013/apr/19/uk-legal-challenge-financial-transaction-tax, George Osborne speaking against the levy, said, -
"I am not against financial transaction taxes in principle," .....But I am concerned about the extra-territorial aspects of the European commission's proposals."

Thinking aloud, - does not the EC’s powers to veto the “Ancillary Restraints” suffer from a like blemish and lends itself scope for being validly challenged on the ground of its “extra territorial aspects” !

That is, of course, a separate topic of interest, left for law experts to explore. In one’s conviction, however, reference to CCI herein does not seem to quite fit into the context; for, it is, most certainly, an altogether different ‘kettle of fish’.

Soumya said...

I refer to your comments made in the blog. You are right in identifying that the article belongs to a highly specialized category of law. It would be right to say anti-trust/ competition law is a branch of law by itself with several countries having competition laws. My article deals with the concept of “ancillary restraints” in relation to M&A transactions and joint ventures. Therefore it is important to bear this background in mind while analyzing the article.
Usually under most merger control regimes globally i.e. when a merger, acquisition or amalgamation is notified before a competition law regulator, the parties to the transaction can highlight certain restrictions under ancillary restraints. Most competition law jurisdictions (including India) recognize that certain contractual restrictions may be directly related to and necessary for the successful implementation of a merger, a decision that clears a merger is deemed to clear such restrictions as well. Usually the most common forms of ancillary-restraints include non-compete clauses, license agreements and purchase and supply agreements.

In response to your query that directly relates to my post (whether CCI or EC has the powers to initiate action if not approached by either party to the contract) my views are:

· The EC in Europe can carry its own investigation into ancillary-restraints, do note that in both the cases discussed in my article the EC itself carried out investigations on its own initiative. With respect to India – we are yet to see a decision where the CCI has investigated a non-compete clause or other ancillary restraints following a merger notification. However from the Orchid/Hospira case one can read that the CCI would like non-compete clauses to be in compliance with competition law and not be excessive in scope or duration. In Europe the “Notice on ancillary restraints” is very useful and it provides clarity on those contractual restrictions that are directly related and necessary to a merger. In India we do not have a guidance note or guideline similar to the Notice on ancillary restraints.
· If a non-compete clause operates as a market sharing arrangement (as in the case of Telefónica and Portugal Telecom) the CCI has the power to investigate the non-compete given the fact it violates the basic principle of competition law under section 3 of the Competition Act, 2002. But I do understand that the CCI usually checks the non-compete clause at the merger notification stage (before clearence is given) and in case the CCI does have any competition concerns, it usually asks the parties to suggest appropriate modifications to address the competition law concerns.
· Also when it comes to financial penalties – operation of illegal non-competes clauses distorts competition when two competitors agree NOT to compete in a given market. It is the common man and the general public at large that will be affected if competitors decide to co-operate with one another instead of competing with each other. it would be useful to note the basic objective of the Indian Competition Act 2002 –

“An Act to provide, keeping in view of the economic development of the country, for the establishment of a Commission to prevent practices having adverse effect on competition, to promote and sustain competition in markets, to protect the interests of consumers and to ensure freedom of trade carried on by other participants in markets, in India, and for matters connected therewith or incidental thereto.”

· Going by the above it is clear that the objective of the Indian Competition Act 2002 is to prevent practices that have an adverse effect on competition and also to protect the interest of consumers. The policy objective behind imposing financial penalties on such companies is to ensure that companies maintain competition and do not distort competition in the market by substituting competition with co-operation.