‘Non-Compete Clauses’ as Ancillary Restraints and Implications Under Indian Competition Law

Introduction

Non-compete clauses (‘NCCs’) make their way into most contracts/agreements between transacting parties. Competition regulators such as the European Commission (‘EC’) and the Competition Commission of India (‘CCI’) consider and analyze NCCs as “ancillary” restraints. Ancillary restraints are restrictions directly related and necessary to transactions, which are entered into by parties to a transaction (i.e. a merger, acquisition or joint venture), simultaneously or in close connection with the main agreement. Such NCCs introduce contractual restrictions to the parties’ commercial freedom of action that may be viewed as anti-competitive if considered in isolation, but such restraints are crucial for attaining the transaction’s economic objectives. Examples of ancillary restrictions include non-compete and non-solicitation clauses, licensing agreements, and exclusive purchase and supply obligations.[1]

EC’s Guidance on Ancillary Restraints

The EC has set out its guidelines on ancillary restraints in ‘Commission Notice on restrictions directly related and necessary to concentrations’[2] (‘EC Guidelines’). According to the EC Guidelines, NCCs must be “directly related and necessary to the implementation of the transaction”. Therefore, the scope (product and geographic), duration and persons subject to the NCC must not go beyond what is reasonably necessary to achieve the legitimate aim of implementing the transaction. Accordingly, the EC Guidelines allow imposing restrictions on licences of patents, similar rights, or of know-how, which can be considered necessary to the implementation of the transaction. These licenses can be simple or exclusive and may be limited to certain fields of use, to the extent that they correspond to the activities of the undertaking transferred.[3] Finally, for transactions involving transfer of an undertaking or a part of it, EC Guidelines allow implementing purchase and supply obligations for vendor and/or purchaser of the undertaking. This ensures maintaining, for a transitional period, the existing or similar links between the vendor and the purchaser of the undertaking.[4]

CCI’s Existing Guidance

To assess ancillary restraints in India, the CCI has also published a guidance note on the broad principles and general approach which it takes into consideration to assess NCCs (‘Guidance Note’)[5]. CCI has clarified in the Guidance Note that the test whether a NCC provision is anti-competitive in nature is directly related and necessary to the implementation of the transaction. While evaluating NCCs, CCI considers the following overarching principles:

i.       Scope: The scope of the NCC (both product and geographic) should be reasonable with respect to the business it seeks to curtail. Excessive curtailment, beyond the objective commercial necessity of the agreement, is considered unreasonable by CCI (for example, in an acquisition, the geographical scope of the NCC covering an area in which the target has not made sales before the transfer would be viewed as excessive curtailment).

ii.      Duration: CCI also considers the duration of the NCC as a primary factor to assess the balance between commercial necessity of the clause and lack of/harm to competition in the market. CCI’s decisional practice demonstrates that it is comfortable with NCCs with a maximum duration of three-four years.

The Guidance Note sets out CCI’s general approach in terms of evaluating NCCs in transaction documentation for transactions that reviewed by it. However, the CCI may still review a NCC in a non-notifiable transaction as an anti-competitive agreement based on a complaint or on its own (for example, by reviewing public reports under the provisions of the Competition Act, 2002 (‘Act’) that relate to anti-competitive agreements.[6]

Identification of NCC as a Horizontal Agreement

A NCC is usually implemented in a transaction to preserve the value of investment being made by the acquirer/ joint venture parents. Therefore, the NCC is aimed at supporting the underlying economic activity, i.e., the transaction being undertaken. As stated above, if considered in isolation, such NCCs may be considered as anti-competitive. Accordingly, it may be possible for the CCI to review these NCCs under the Act provisions relating to anti-competitive agreements (Section 3(1) read with Section 3(3) of the Act).

Section 3(3) of the Act prohibits any arrangement between active or potential competitors which may directly or indirectly determine purchase or sale prices, limit or control production and supply, and directly or indirectly lead to bid rigging (‘Horizontal Agreements’). Horizontal Agreements are presumed to cause an appreciable adverse effect on competition (‘AAEC’) in India and are therefore void. However, the proviso to Section 3(3) of the Act exempts efficiency enhancing joint ventures from being considered as anti-competitive.

Points to be considered when CCI assesses these under Section 3(3)

A few points that the CCI is likely to / should consider in assessing NCCs under Section 3(3) are:

i.       The CCI is likely to use the same analytical framework provided under the Guidance Note to assess reasonability of NCCs in transactions that are not notifiable to the CCI (i.e., reasonable based on scope and duration). In addition, it will consider whether in the absence of such NCCs the primary transaction could not be implemented or could only be implemented under considerably more uncertain conditions, at substantially higher cost, over an appreciably longer period etc.;

ii.     The CCI should also consider whether any efficiencies arise as a result of such NCCs. Of course, the onus would be on the parties to demonstrate the efficiencies to the CCI in form of lower prices or better quality of services to customers; and

iii.     Given that the ambit of Section 3(3) of the Act would apply to competitors (whether actual or potential), the CCI should first assess whether the parties to the NCC are actual and potential competitors. For its analysis on potential competitors, the CCI should assess whether the parties to the NCC intend to be active in the same market. It should not, without any reasonable basis, apply the presumption of AAEC being caused as a result of the NCC.

Conclusion

The implementation of ancillary restraints requires a fine balance between fostering a healthy environment for business transactions and maintaining effective competition in the market. Given this, it is necessary for transacting parties to ensure that the ancillary restraints considered by them do not go beyond what is strictly necessary for them to protect their investments. Similarly, the CCI should also consider such restraints holistically after considering both the benefits and the potential harm that may be caused by such restraints.

[1] See: EC Merger Regulation and the Status of Ancillary Restrictions: Evolution of the European Commission’s Policy, available at: https://www.hoganlovells.com/~/media/hogan-lovells/pdf/publication/eclrmetaxasarmengod0805_pdf.pdf
[2] See: https://eur-lex.europa.eu/legal-content/EN/TXT/PDF/?uri=CELEX:52005XC0305(02)&from=EN
[3] Ibid
[4] Ibid
[5] See: https://www.cci.gov.in/sites/default/files/Non-Compete/Guidance_Note.pdf
[6] Recently, the CCI has begun the practice of distinguishing between ancillary and non-ancillary NCCs in its approval orders. Accordingly, for non-ancillary NCCs, the CCI retains a right to subsequently scrutinise these under its antitrust provisions. (See Atos/Syntel available at: https://www.cci.gov.in/sites/default/files/Notice_order_document/C-2018-08-592%20%28for%20uploading%29.pdf)

Published In:Inter Alia Special Edition- Competition Law - January 2020 [ English
Date: January 17, 2020