noncompete obligations when are they lawful

7/25/2019 Noncompete Obligations When Are They Lawful

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The purpose of competition law is to ensure that companies

compete with each other: in a market economy, this is the

best way of ensuring that consumers benefit from competition

between suppliers, in terms of lower pr ices, improved product

quality, innovative new products and greater choice. Therefore,

companies that agree not to compete with each other will

usually be regarded as engaging in cartel behaviour and face

heavy fines for anti-competitive market sharing. That said,

in certain circumstances, non-compete obligations (and

other obligations with a similar effect) are regarded as being

objectively justifiable and even, for a period, pro-competitive,

and therefore lawful, for example in the context of a merger or

the formation of a joint venture.

In this briefing, we examine, by reference to recent decisions

of the European Commission, when non-compete obligations

will be lawful and when, conversely, they will give rise to serious

competition law concerns. The dividing line between what is

and is not lawful is not always clear and expert legal advice

should be sought, both to protect against the risk of serious

fines and to ensure that, whenever possible, your commercial

interests and objectives are protected to the maximum extent.

If you would like to discuss any of the issues raised in this

briefing, or to obtain legal advice on any specific concerns,

please contact one of the members of our Competition Unit or

your usual Burges Salmon contact.

The basic position: non-compete agreements

Competition laws, including Chapter I of the UK Competition

Act 1998 and Article 101 of the Treaty on the Functioning of the

European Union (TFEU), prohibit anti-competitive agreements

and practices.

It is therefore prohibited for companies that are actual or

potential competitors to agree not to compete with each other,

including by sharing geographic markets or customer groups.

This does not just cover express (or implied) non-compete

obligations or covenants, but also other obligations with

equivalent effect that restrict a companys ability to compete,

including: cover pricing, bid-rigging, customer and employee

non-solicitation obligations and restrictions on the use of

confidential information.

Such agreements will generally be considered as hard core

cartels and parties to them will be punished accordingly, with

companies facing heavy fines and, in some countries (including

the United Kingdom), individuals being at risk of criminal

prosecution.1 In the European Union, this approach is clearly

exemplified by very heavy fines imposed for bilateral non-

compete agreements in the gas and telecoms sectors, under

which the parties essentially agreed not to compete in each

others home markets.

E.ON/Gaz de France:very heavy fines formarket sharing as part of pipeline project

In 2009, the European Commission imposed fines of 553

million on each of E.ON and Gaz de France for illegally agreeing

not to compete with each other in their respective domestic

markets. In the 1970s, the companies had jointly constructed a

pipeline to import gas from Russia to Germany and France, but

also agreed not to compete with each other in their respective

countries. Once European gas markets had been liberalised, this

agreement infringed competition law. On appeal, the General

Court confirmed that the agreement was anti-competitive,

albeit for a shorter period than that found by the Commission. It

therefore reduced the fines to 320 million each.

Telefnica/Portugal Telecom:significant fines

for non-compete on termination of joint venture

In 2010, two telecoms operators, Telefnica and Portugal

Telecom, ended a mobile joint venture in Brazil, Vivo, with

Telefnica acquiring Portugal Telecoms shareholding in Vivo.

However, the companies inserted into the sale and purchase

agreement a clause by which they agreed not to compete with

Briefing

Competition

Non-compete obligations: when are they lawful?

1 For proposals to revise the UKs criminal carte l offence, see our briefing of May 2012, Government announces reform of UK competition law and

establishment of a new competition authority and OFT consults on revising its enforcement procedures.

May 2013
http://www.burges-salmon.com/Practices/commercial/Publications/Government_announces_reform_of_UK_competition_law.pdfhttp://www.burges-salmon.com/Practices/commercial/Publications/Government_announces_reform_of_UK_competition_law.pdfhttp://www.burges-salmon.com/Practices/commercial/Publications/Government_announces_reform_of_UK_competition_law.pdfhttp://www.burges-salmon.com/Practices/commercial/Publications/Government_announces_reform_of_UK_competition_law.pdf


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each other in their respective home markets of Spain and

Portugal (in which each was the largest operator) between

September 2010 and the end of 2011.

The Commission subsequently became aware of this

agreement and started an investigation on its own initiative.

In January 2013, even though the companies had voluntarily

terminated the non-compete agreement in February 2011, after

the Commission had started its investigation, the Commission

imposed substantial fines for illegally partitioning the Iberian

telecoms markets for a four month period: Telefnica was fined

66.9 million and Portugal Telecom 12.3 million for a serious

infringement of the competition rules. These fines would have

been even higher but for the companies cooperation with the

Commission and voluntary termination of the non-competition

pact. Both companies have appealed to the General Court.

Exceptions to the basic position: non-competes

in the context of mergers and joint ventures

under the ancillary restraints doctrine

Non-compete covenants (and those of similar effect, such

as non-solicitation obligations and prohibitions on acquiring

interests in competitors) are common in M&A transactions and

joint venture agreements. Indeed, without them, transactions

would often lose their entire economic rationale.

The purchaser of a business will usually have paid a significant

sum for goodwill and often also technology and know-how.

The purchaser will, self-evidently, wish to protect the value of its

investment by preventing the seller from immediately competing

with the business that it has just sold and about which it will

have commercially valuable knowledge and information. From

the sellers perspective, giving a non-compete covenant can

increase the sale price.

In some cases, the business being sold may possess

commercially valuable information about the businesses being

retained by it the seller, which may wish to prevent the buyer

using this information.

In the case of joint ventures, each parent company will wish

to protect its investment in the joint venture and also sensitive

commercial information and know-how it contributes to the

joint venture, as well as to prevent free riding by its partners

unfairly using this information.

Competition law takes account of these commercial realities

through what is known as the ancillary restraints doctrine.

This applies to contractual restrictions, such as non-compete

obligations, that are directly related to and necessary for the

successful implementation of a merger or joint venture. Guidance

on the application of this doctrine is provided in the Commissions

Ancillary Restraints Notice, which applies irrespective of whether

the merger or joint venture is required to be notified to the

Commission under the EU Merger Regulation.

It is important to note that, in assessing a merger or joint

venture, the Commission will not conduct a separate

assessment of whether any contractual provision (such as a

non-compete obligation) is within the scope of the ancillary

restraints doctrine: it is for the parties to themselves assess

whether restrictions, such as non-compete clauses, are

ancillary to their transaction. The only exception is where

a case gives rise to novel or unresolved questions such

that there is genuine uncertainty as to the application of the

law: however, we are not aware of any case in which the

Commission has given such guidance. Furthermore, where

the ancillary restraints doctrine is not applicable, the provisions

must be self-assessed for legality under Articles 101 and 102

TFEU (and national equivalents).

Mergers and acquisitions

The ancillary restraints doctrine applies to non-compete obligations

accepted by the seller in an M&A transaction. This recognises thatthe purchaser must have sufficient time (but no more) to assimilate

and exploit the goodwill and know-how of the acquired business

before it is subject to competition from the seller.

Non-compete clauses restricting the sellers ability to compete

with the divested business will generally be classed as

ancillary restraints (and thus permitted) for a duration of up

to three years where goodwill and knowhow are transferred

and two years where only goodwill is transferred. Only in truly

exceptional circumstances may a longer duration be objectively

justifiable and in view of the European Commissions generalapproach to non-compete obligations, it should be assumed

that three years is the maximum permissible duration. In

addition, the obligation must be limited to the product and

geographic areas in which the acquired business was active or

was intending to enter.

The ancillary restraints doctrine does not apply to restrictions

accepted by the buyer. However, in rare occasions, non-

compete provisions accepted by the buyer for the benefit of

the seller might be considered as objectively justified (and thus

lawful), albeit for a more limited scope and/or duration, for

example to prevent solicitation of the employees or customers

of a retained business or the use of confidential information

about the retained business that unavoidably must be

transferred to the buyer as part of the business being sold.

Joint ventures

The EU Merger Regulation applies to full-function joint ventures

which are set up on a lasting basis as an autonomous economic

entity active on a market. However, the principles of the ancillary

restraints doctrine are equally applicable to partial function joint

ventures which are assessed under Article 101 TFEU. In a jointventure scenario, non-compete provisions may apply to the

parent companies and/or to the joint venture itself.


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Obligations accepted by the parent companies (provided

that they have a controlling interest in the joint venture) not to

compete with the joint venture in its specified areas of activity

(in terms of products and geographic area) are normally

ancillary for the lifetime of the joint venture. This is also the

case for restrictions on the parent companies use of knowhow

and intellectual property that has been licensed to the joint

venture. However, restrictions on the ability of the parents to

supply inputs (such as raw materials or content in broadcasting

markets) to competitors to the joint venture may be ancillary

only for a shorter period (typically three years), where this

would be sufficient to enable the parties to recoup their initial

investments and a longer period would foreclose rivals from the

markets on which the joint venture is active.

It is usual for the parent companies, in establishing the joint

venture, to define the scope of its products and geographical

area of activity, thereby restricting its activities. This is inherent in

the creation of the joint venture, so is unlikely to raise competition

concerns. Agreements between the parents not to compete with

each other in products or geographic areas that are outside of

the scope of the joint venture will not be ancillary and are likely to

be regarded as anti-competitive market sharing.

Limits to the exception for ancillary

restraints: theAreva/Siemenscase

The ancillary restraints doctrine is not unlimited in its application in

terms of the nature, scope and duration of contractual restrictions

on a companys ability to compete. In addition, as explainedabove, competition authorities do not themselves apply the

doctrine on an ex ante basis when examining a notified merger

and many transactions may not even satisfy the thresholds

for a merger notification. Therefore, parties must self-assess

the application of the doctrine, which, as is clear from a recent

Commission investigation involving Areva and Siemens, exposes

them to a degree of both regulatory and commercial risk.

In 2001, in a transaction approved by the Commission under

the EU Merger Regulation, Areva and Siemens created a joint

venture, Areva NP, to combine their civil nuclear technology

businesses, which would supply nuclear power plants, reactor

services and fuel assemblies. It was agreed that, following a partys

exit from the joint venture, the departing party could not compete

with the joint venture for up to eleven years. In 2009, Siemens

withdrew from the joint venture by exercising a put option and

selling its stake to Areva. Siemens subsequently announced its

intention to re-enter the civil nuclear business in partnership with

a Russian entity. Areva therefore sought to enforce Siemens

non-compete obligations. Amongst other defences, Siemens

complained to the Commission that the obligations infringed EU

competition law and were thus unenforceable, even after theirduration had been reduced to four years as a result of arbitration

proceedings between Siemens and Areva.

The Commission considered that post-dissolution non-compete

restraints were not relevant to the creation of the joint venture

and so could not be ancillary to that transaction. However, it

did accept that the restraints could, in principle, be ancillary to

Arevas acquisition of sole control of Areva NP, given Siemens

privileged access to Areva NP confidential information during the

lifetime of the joint venture. However, it considered the duration

and scope of the restraints were excessive, infringed Article

101(1) and not capable of exemption under Article 101(3) TFEU.

It therefore required significant modifications to the obligations

to make them compatible with Article 101. Areva and Siemens

offered commitments to do so, in order to avoid potentially

significant fines. The Commission accepted these commitments,

which were made legally binding in June 2012.

The Commission was only prepared to accept the following

post-termination restraints on Siemens:

a worldwide non-compete obligation of three years inrespect of the core products manufactured and sold by

the joint venture: this was, in its view, sufficient to protect

Arevas interests, as after three years the information

to which Siemens had had access would have lost

commercial and strategic relevance

no non-compete obligation at all in relation to other non-core

nuclear-related products that had not been manufactured by

the joint venture, even if they had been used or resold by it

(such as components for nuclear plants and the conventional

(non-nuclear) parts of a power plant, which Siemens

continued to make outside of the joint venture)

an unlimited obligation not to use confidential

technological know-how of the joint venture or Areva:

this did not restrict competition, as Siemens could still

compete using its own technology

an unlimited obligation not to disclose confidential

information relating to the joint venture or to Areva: this did

not prevent competition by Siemens

The non-compete obligations to which Siemens remained

subject covered not only direct competition, but also:

developing core products, acquiring or holding more than

10% of the capital or voting shares in any entity supplying

core products, and using confidential business information

relating to the joint venture or to Areva.

It is notable that the Commission drew a distinction between

restraints on the exiting shareholders post-termination use

of technology and know-how, on the one hand (which do

not restrict competition at all) and of confidential business

information on the other (which do restrict competition and thus

can be allowed only for a transitional period). It is also notable

that the Commission was strict in permitting, as ancillary, a

non-compete obligation only for the products and services


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actually made by the joint venture (which were exhaustively set

out in the revised non-compete obligation), even if Siemens

also supplied other, complementary products also purchased

by the same customers, operators of nuclear power plants.

Commentary: are your non-compete provisions

compatible with EU competition law?

In order to ensure the enforceability of non-compete obligations

and to avoid the potential risk of fines, parties to agreements

containing non-compete clauses or similar restrictions must

ensure that these restrictions are directly related to and

necessary for the implementation of their transaction. Equally, a

party bound by a non-compete obligation may wish to consider

whether competition law could provide a basis for to be found

to be the obligation unenforceable.

Particular regard should be had to the duration, product

scope and geographical field of application of any restrictions,

to ensure that they are objectively justifiable, necessary and

proportionate to the interests being protected. Whilst restraints

falling outside of the ancillary restraints doctrine can, in

principle, benefit from exemption under Article 101(3) TFEU (on

the basis that they create efficiencies or benefits to consumers),

in reality non-compete obligations that do not fall within the

ancillary restraints doctrine are extremely unlikely to be

capable of exemption and would therefore be unenforceable.

It is therefore important to conduct a thorough competition law

assessments whenever the inclusion of non-compete clauses

and other restrictions in transaction documents and other

commercial agreements is considered.

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Burges Salmons Competition Unit is one of the United

Kingdoms leading competition practices. We undertake

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Should you require any further information on the issues

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law matter, please contact your usual contact or one of the

members of our Competition Unit.

Laura ClaydonPartner

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Burges Salmon Competition Unit

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noncompete obligations when are they lawful

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